Calculating ROI to compare investments

Guys,

I'm currently presented with two different investments and while trying to compare them on a numbers only basis, I think I'm confusing myself. Investment 1 is simple. It pays 13% on cash invested. Investment 2 is a leveraged IP and I'm unsure specifically if I should include the principal portion of a payment in the return calculation.

Eg: My repayments would be $7440 of which $1665 is principal. Cashflow is projected at $5422/year and I'll put down $67,800 for purchase costs. 5422/67800 gives a return of 8%. This is just cashflow though correct? Would I not have to add back in the principal payment as my value in the property by paying off the loan? (5422 + 1665) / 67800 gives a return of 10.45%. What's the best way to accurately compare these two different investments? Thanks!

 

Two questions.
1. Will the value of the underlying asset increase for both investment 1 and 2? What is the expected asset growth?
2. Why are you thinking P+I for the IP? Perhaps 5 years down the track the lender may require your investment to be paid back on a P+I, but in general I think you'll generally have better things to do with your money than pay down the principal on an IP right now (I'm assuming you are fairly young).

 

Use the NPV & IRR functions in excel base your calculations on 100% borrowed funds.

 

Gockie,
1. No. The first investment is essentially a cash loan. No asset to speak of. I have included some capital appreciation when calculating asset 2 but the principal payment is the part i'm getting stuck on wether to include or not.
2. I don't have a choice. The IP and loan is overseas and they won't do interest only loans.

 

I would be looking at the returns on an unleveraged basis i.e. before debt repayments. The first principle of corporate finance theory (and I am aware this is property chat, not share chat) is that the value of an asset is independent of how it is financed.

 

Hamish,
Makes sense but then how do I end up with a 'real world' scenario when only one of these investments offer (and requires) financing? Leverage is a tool we use to potentially multiply our returns.

 

@mnschwarz - see post on excel. IRR allows comparison across different investment classes.

 

@Scott No Mates I can use IRR but it doesn't answer my question. Should the principal part of a loan payment be included or not? The IRR will differ greatly if paying P+I or IO for example even though the investment is the same. I'm not trying to work out cashflow. I'm trying to work out net return on investment.

 

Exclude it as you aren't considering it with the other options.

 

Ok I think this makes sense with the IRR. Though I had to make a lot of assumptions. I estimated yearly increases for cashflow and yearly capital appreciation. Then chose a year to sell at this estimated appreciated value minus the outstanding loan.

Final result shows an IRR of 11.5% if held 5 years and 13.8% if held 10 years, increasing from there. So I guess from a numbers only perspective the IP is a better option if held long term. Sound about right?

 

Sorry to butt in with a noob question, but what is IRR?

 

Internal Rate of Rate

 

Internal rate of return

 

Hah half asleep when I wrote that obviously! Thanks for the correction.