Meeting documents

Discounted cash flow (DCF) analysis may be used to assess the internal rate of return (IRR) received from a property asset. By applying an anticipated income stream over a given holding period, while allowing for growth and outgoings, the DCF will calculate a discount rate that will produce the equivalent capital value. The IRR accordingly represents the overall annual rate of return that the investment will generate.

The DCF comprises three basic elements:

• Entry Value.
  
• Income and expenditure stream over the holding period
  
• Exit Value

The DCF starts with an entry value, which represents the opportunity cost of acquiring that asset. This value is generally taken as the current asset value of the property. An income stream is then applied over a specified holding period, net of any expenditure. A growth rate will be selected which can then be applied to the property's full rental value at any review of rent during the holding period. At the end of the holding period the DCF will show an exit value, calculated by applying a reversionary yield to the FRV with applied growth as at the exit date.

The "Hurdle" Rate

The internal rate of return produced from a property asset will be assessed against a hurdle rate. If the property produces an IRR, which exceeds the hurdle rate then it can be deemed to be performing well as an investment asset and should be retained.

It is proposed that the hurdle rate is represented by either the opportunity cost of an alternative investment or the cost at which the Council could borrow capital.

It is suggested that further consideration is given to identifying and eventually selecting the most appropriate indicator to use as the "Hurdle" rate.