Question

A closed-end, commingled opportunity fund is being created with an expected three-year life. It expects to acquire properties that it expects to turnaround and sell at the end of three years for a gain. It also plans a minimum target return of 10 percent to investors, which will be based on cash distributions from operations and from the sale of properties at the end of the life of the fund. The opportunity fund manager expects to receive a promote equal to 25 percent of cash flows remaining after sale of the assets and after equity investors receive their minimum 10 percent target return. Cash flows are expected as follows: Equity Investment Cash Distributions from Operations to Equity Investors (After Management Fees) Expected Sale Proceeds Year 0 $ 2,600,000 Year 1 $ 80,000 Year 2 80,000 Year 3 80,000 $ 3,600,000 Required: a. What must be the cash flows to equity investors at the end of year 3 in order to achieve their total target 10 percent return on equity investment

Answer 1

Based on the cashflows in the previous years and the present value, the cash flows to equity investors at the end of year should be $3,275,800.

What should be the cashflow at the end of year 3?

The cashflow at the end of year 3 should have a present value that when added to the present value of the cashflows in years 1 and 2, will equal the present value of the investment of $2,600,000.

That amount is:

2,600,000 = (80,000 / ( 1 + 10%)) + (80,000 / ( 1 + 10%)²) +( Amount / ( 1 + 10%)³)

2,600,000 = 138,842.9752 + ( Amount / ( 1 + 10%)³)

( Amount / ( 1 + 10%)³) = 2,600,000 - 138,842.9752

Amount = 2,461,157.0248 x 1.1³

= $3,275,800

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