Property Valuation: Investment Analysis and DCF Shortfalls

This report provides an analysis of property valuation methods, focusing on investment appraisal and the discounted cash flow (DCF) method. It discusses the shortfalls and limitations of DCF, including assumptions related to cash flow projections, discount rates, growth rates, and terminal cash flows. The report assesses the impact of these assumptions on property valuation, highlighting the importance of considering factors such as inflation and market conditions. Through calculations and analysis, the report determines the relative value of different investment options, ultimately recommending the most viable one while acknowledging the inherent uncertainties and the need for regular review and modification of DCF valuations. The report concludes that DCF is most feasible when there is confidence regarding expected cash flows.

Running head: VALUATION OF PROPERTY
Valuation of Property
Name of the Student:
Name of the University:
Author’s Note:

1VALUATION OF PROPERTY
Executive Summary:
This report aims at explaining and understanding the methods of project appraisal or
valuation of investments. In this report the shortfalls of discounted cash flow method has
been explained and the reasons behind such shortfalls has been mentioned. The report has
analyzed in such a way that the reader can understand the viability of the investment in
property. The major assumptions and limitations of the discounted cash flow method has
been mentioned with through analysis of the impact of such assumptions on the valuation of
the property. Lastly the report concludes with a recommendation about the most viable
investment option from the available alternatives.

2VALUATION OF PROPERTY
Table of Contents
1. Introduction:...........................................................................................................................3
2. Valuation of property:............................................................................................................4
3. Conclusion:............................................................................................................................9
4. References:...........................................................................................................................10
5. Appendix;.............................................................................................................................11

3VALUATION OF PROPERTY
1. Introduction:
The Valuation of property is the technique of determining or projecting the value of
assets such as land, building, intellectual property rights, etc. based on the expected economic
benefit, resale price, income, rent,or such other factors, which may directly indirectly related
to the property. In valuation, the present value of the asset is determined using NPV
approach.
Valuation is required for many purposes such as capital budgeting, investment appraisal,
business combinations, determination of Tax liability and financial reporting. Value of things
is a time determinant. Therefore, valuation is generally done on specific date. It is possible
for valuation experts to make their own estimates for valuation of assets depending upon
different kind of variables, which may affect the future economic benefit from such assets.
2. Valuation of property:
The valuation of property is the task of valuing based on certain assumptions
regarding methods of valuation and such other factors having direct impact on the value of
assets. The principle of valuation states that it may happens so that the value so determined
may not acceptable by everyone but while determining value of the property or assets,
valuation expert should have given due consideration to variable factors such as inflation rate,
capitalization rate and discount rate to be used for such valuation. Followings are the major
components of the valuation process:
a) The internal rate of return,
b) Effect of inflation on the expected cash flow,
c) Capitalization of income method or discounted cash flow method,
d) Terminal outflow in the project.

4VALUATION OF PROPERTY
Following table shows the calculation of the value of the property:

5VALUATION OF PROPERTY

6VALUATION OF PROPERTY

7VALUATION OF PROPERTY

8VALUATION OF PROPERTY
Following assumptions have been made while calculating the value of the property:
1. Cash flow projections: The underlying assumption, which is mostly used in
valuation of assets or properties, is the projection of cash flows. The cash flows are
mainly assumed to be occurred at the year-end whereas it can happen that the cash
flow or benefit can be occurredthroughout the year instead of particular date.
2. The discount assumption: Most common assumption in valuation model is discount
rate or growth rate assumption. Most of the time WACC or Hurdle rate has been used
to determine the discount rate. Perhaps both the rates may not work in real world or
will not widely accepted all interested parties.
3. Constant growth rate assumption: The major assumption under valuation principle
is that the inflow and outflow will grow at same rate. The inflow and outflow may not
grow at same rate. It may happen that the market conditions for both variables will not
be same. It can be a fall in the rental income with the increase in the rate of outflows
leading to overstated value earlier.
4. Constant capital growth rate and return from the property: The capital growth
rate and the expected return from the capital is assumed to be consistent over medium
to long range. However, in real scenario it cannot happen so. The capital growth rate
and the expected return may change over the time.
5. Projection of terminal cash flows: The projection of terminal cash flow through sale
or disposal of such property is mainly dependent upon the present market conditions.
Any fluctuations in the terminal cash flows may lead question the reliability of the
valuation model.
6. Use of discount rate of similarindustries: The use of discount rate used by similar
industry or company by the company to evaluate economic feasibility of the project
has some pitfalls. Those similar industries may have different risk factors or required

9VALUATION OF PROPERTY
return from the capital and it can be based on certain assumptions, which may or may
not be applicable for the company.
The valuation of property needs appropriate data regarding capitalization rate, certain cash
flows, terminal value to be achieved, inflation rates and growth rate. However in above
calculations additional assumptions has been made, explained below:
i. The discount rate that has been used to calculate present value of cash inflows is the
average of the discount rate of comparable investment properties. Using the discount
rate of comparable investment properties of same nature may have great advantage.
The rate will consist of same level of risk and uncertainties that may arise during the
life of the project. Therefore, the use of comparable rate of return is of great
advantage.
ii. Capitalization rate has not been used while calculating the discounted cash flow
because the concept of capitalization rate is useful where there is no prediction
regarding how many years the cash flow will continue to arise. The cash flow will
continue to arise in infinity.
iii. Leasing costs, acquisition costs and disposal costs are calculated on total expected
inflow from the property. However, leasing costs and acquisition costs should be
calculatedon the initial cost of the lease.
iv. Inflation has major importance in the valuation of the property. The inflation may
change over the time. Inflation rate has been adjusted in the expected cash inflow as
well as expected future cash outflows.
v. Market review for rental of the leased property has not exceeded the inflation factor.
In above calculation, expected rental receipts are either based on the inflation if the
market review estimates are more than the inflation rates and are based on market rate
if inflation rate is more than market estimates.

10VALUATION OF PROPERTY
3. Conclusion:
From the above discussion and calculations, it can be concluded that the unit 1 is
more valuable as compared to other units. However, there are certain assumptions, which
may change the expected result. The discounted cash flow method is useful but it has lots of
errors and assumptions relying completely on which will not be advisable and will expose the
company towards some uneven risk that may arise during the life of the project. DCF
valuation requires regular review and modifications. In case of change in expectation in the
estimates of the company, the economic benefit will be changed accordingly. DCF is feasible
when the company has confidence regarding the expected cash flows. Any deviations in the
company’s operational visibility may lead to difficulty in the prediction of rental income,
operating expenses and capital investment.

11VALUATION OF PROPERTY
4. References:
Behr, A., Mielcarz, P., &Osiichuk, D. (2018). TERMINAL VALUE CALCULATION IN
DCF VALUATION MODELS: AN EMPIRICAL VERIFICATION. e-Finanse, 14(1), 27.
Cifuentes, A. (2016). The discounted cash flow (DCF) method applied to valuation: Too
many uncomfortable truths.
Damodaran, A. (2015). Discounted Cash Flow Valuation: Basics. Retrieved June.
French, N., &Gabrielli, L. (2018). Pricing to market: Property valuation revisited: the
hierarchy of valuation approaches, methods and models. Journal of Property Investment &
Finance, 36(4), 391-396.
Gajek, L., &Kuciński, Ł. (2017). Complete discounted cash flow valuation. Insurance:
Mathematics and Economics, 73, 1-19.
Green, J., Hand, J. R., & Zhang, X. F. (2016). Errors and questionable judgments in analysts’
DCF models. Review of Accounting Studies, 21(2), 596-632.
Kucharska-Stasiak, E., &Źróbek, S. (2015). An attempt to exemplify the economic principles
in real property valuation. Real Estate Management and Valuation, 23(3), 5-13.
Saha, A., &Malkiel, B. G. (2015). DCF valuation with cash flow cessation risk.