Engineering Economics - Combined return with cost to fix it?

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Discussion Overview

The discussion revolves around the evaluation of investment returns for a used widget producing machine, specifically focusing on the calculation of average returns over time and the implications of refinancing costs. Participants explore concepts related to discounted cash flow analysis and its applicability to different types of investments, particularly residential versus commercial properties.

Discussion Character

  • Technical explanation
  • Debate/contested
  • Mathematical reasoning

Main Points Raised

  • One participant calculates an initial return of 30% based on specific costs and questions whether refinancing affects the denominator in the return calculation.
  • Another participant asks for a list of cash flows associated with the investment, indicating a focus on discounted cash flow analysis.
  • A participant distinguishes between commercial and residential investments, suggesting that discounted cash flow analysis may not be applicable for residential appraisals in their area.
  • One participant asserts that discounted cash flow is the only valid method for evaluating investments, expressing frustration over the lack of cash flow details provided by others.
  • Another participant agrees that discounted cash flow is useful for determining maximum allowable offers but argues that it is not relevant for their investment strategy, which involves long-term trusts or sales.

Areas of Agreement / Disagreement

Participants express differing views on the relevance and application of discounted cash flow analysis, with some advocating for its use while others question its applicability to residential investments. There is no consensus on the best method for evaluating the investment in question.

Contextual Notes

Participants highlight the importance of cash flow timing and the potential impact of refinancing on investment returns, but there are unresolved assumptions regarding the valuation of costs and the applicability of various methodologies.

adamaero
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Homework Statement
What is the return?
Relevant Equations
NOI/(downPayment+rehab)
Say the annual return for a *used* widget producing machine is this:
`12*500/(5000+15000)` = 30%
It cost 5k for the loan to buy the machine and 15k to fix it to start.

Two years later, it is refinanced for a 30 year term. Is that initial 15k still in the denominator? What if it was refinanced two seconds later?

`12*600/(33000+15000)` = 15%

I am trying to determine the overall (average) return of an investment with a great return in the first two years, but a mediocre return for the rest of the new loan.

`(2*30% + 30*15%)/32` = 16% average
 
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Are you familiar with "discounted cash flow analysis?" Can you please list the cash flows for this investment and the times that each of these cash flows occurs?
 
Chestermiller said:
Are you familiar with "discounted cash flow analysis?" Can you please list the cash flows for this investment and the times that each of these cash flows occurs?
Yes, this is used for commercial. I am exclusively looking at residential investments. So while it could be used for fun, an appraiser would not use it in their valuation (at least in my area).

I realized two options could be a solution. I first tried to assume the cost to fix does not improve the value. Instead I should have the value increasing 0.5:1 or even as much as 1:1. Alternatively, an ARV could be used.
 
Discounted cash flow is the only meaningful and valid method of evaluating an investment (in my judgment). I can see that you are not willing or are unable to make a list of cash flows vs time for the various alternatives. Sorry to hear that. If you do list the cash flows for the various alternatives, I would be pleased to evaluate the ROI for you (using continuous compounding or compounding at specified intervals). Otherwise, I'm not going to be able to help you consider alternatives using inferior methodologies..
 
Oh, I agree as a tool to determine a maximum allowable offer (MAO). But for the deal analysis as the question is posed it doesn't make much sense.

Evaluating ROI also does not apply in this case and especially not for the purpose of my investment strategy. All investments will be put into trusts or sold off at such a far off date that there is no use to speculate on what they will appreciate to then.
 

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