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Discounted cash flow (DCF), whether by capitalisation or by cash flow analysis, has many detractors because of a number of apparent problems such as the reinvestment assumption and the possibility of multiple rates of return. The capital recovery cum reinvestment aspects of Years' Purchase (YP) factors and DCF are discussed and it is demonstrated that Years' Purchase single rate principle is akin to Internal Rate of Return (IRR) and that Years' Purchase dual rate principle also has a DCF image known as the Modified Internal Rate of Return (MIRR). The difference between the YP models and the DCF models is to do with the level cash flows assumed in the former and the variability of the cash flows measured in the latter. MIRR was developed as an answer to the above problems and it is demonstrated in a case study in which the fallacy of the apparent problems is also demonstrated. MIRR has a place in the analysis of investment strategy, but IRR (equated yield) is shown to be satisfactory in the financial analysis and comparison of individual projects.

Employs discounted cash flow analysis as a valid method for valuing future cash flows from property investments. The method has regard to the market participants' investment behaviour and thus is able to encapsulate the economics of the investment decisions made; particularly by institutional investors. Observes, however, that there has always been serious concern about discounting property investment returns using discount rates that predicate long‐term bond yields. Reports on a comparative study between Australian ten‐year bond and the prime Sydney and Melbourne office yields which has been carried out to find out if there is a correlation. The relationship between the two yields for period March 1980‐March 1995 shows an inverse relationship, i.e. a negative correlation between the two yields. The result is consistent for both studies. The actual f‐value of 89 for Sydney office yields versus bond yields and 110 for Melbourne office yields versus bond yields, respectively, when compared with the table f‐value of 7.08 for the data set, indicate that the negative relationship is significant. Argues, in addition, that the achieved R2 of 60 and 65, respectively, indicates that the explanatory power of the model is acceptable. So a discount rate based on bond yields, in the rising bond market, will indicate a higher future return from the property investment. Concludes that the result is totally flawed, given the inverse relationship between bond and property yields, because the actual future return will be lower; and that, as a result, in the rising bond market the prospective property investors who ought to achieve higher future return will actually end up achieving a lower return. A converse flawed result will be achieved in the falling bond market. In this market the vendors using this method to calculate the exit value of their investments are actually accepting an incorrect lower price.

PurposeValuation is the process of estimating price. The methods used to determine value attempt to model the thought processes of the market and thus estimate price by reference to observed historic data. This information is utilised in the discounted cash flow (DCF) valuation model to determine the single point valuation figure. However, the valuation will be affected by uncertainties: uncertainty in the comparable data available; uncertainty in the current and future market conditions and uncertainty in the specific inputs for the subject property. These input uncertainties will translate into an uncertainty with the output figure, the estimate of price. This paper discusses ways in which uncertainty can be incorporated into the DCF model.Design/methodology/approachThis paper looks at the way in which uncertainty can be incorporated into the explicit DCF model. This is done by recognising that the input variables are uncertain and will have a probability distribution pertaining to each of them. Thus by utilising a probability‐based valuation model (using Crystal Ball) it is possible to incorporate uncertainty into the analysis and address the shortcomings of the current model.FindingsThe outcome of introducing uncertainty in the inputs is to produce a range of different answers. The central tendency of this distribution is very close to the single point estimate of the static model, yet the user of the technique now benefits from an understanding of the upside and downside risk pertaining to this single point estimate.Originality/valueThis study contributes significantly to the practical application of probability‐based models to valuation. In particular, the findings from the study will be useful for clients to understand better the context in which a valuation figure is provided to them.

Purpose– The purpose of this paper is to address the apparent slow acceptance on the part of developers located in the USA to seek green certifications. If green-certified construction costs more than non-green construction, then is there a financial reason for not seeking a green rating. Do green buildings perform better than non-green buildings financially? The paper develops and presents a discounted present value model for doing a cost-benefit analysis for building green. This model enables an investor to determine the feasibility of constructing a new green-certified building instead of a conventional non-green building. Non-green buildings are not certified by a rating agency such as Leadership in Energy and Environmental Design (LEED), Energy Star or Building Research Establishment Environmental Assessment Method (BREEAM). Real estate permits are granted by local municipalities in the USA. This means that local government mandates requiring green construction that significantly adds to the initial cost of a project could have the unintended result of encouraging new non-green construction just outside their municipal boundaries.Design/methodology/approach– The paper collects publically available research data for office buildings located in the USA, and inputs this information into an income statement. It tests the hypothesis: is green-certified construction a financially feasible choice for an investor? An incremental approach using a 15-year holding period is presented. This time period takes into account equipment wear and tear. Heating/cooling systems and other green-technologically based operating systems have a limited life and do not last for 30 or 40 years. They are likely to need replacement after 15 years have lapsed.Findings– The negative net present value (NPV) results and high payback periods indicate that increased rents for green construction, a tax credit for the present value loss and/or property-tax reduction covering the shortfall is needed as an incentive to commercially build green. The implication of a negative NPV is that green office buildings will be built by government agencies where green is mandated, corporations that want a green image and benefit from this image, where local ordinances mandate green construction features and where local and federal tax incentives are available increasing a construction project's feasibility.Research limitations/implications– The limitation of any cost-benefit study is that analytical models and/or data used to forecast energy and water consumption savings in green-certified buildings compared to conventional buildings can be inaccurate. Forecasting models can understate or overstate the actual savings realized from green construction especially in the long-term given the difficulty of predicting equipment wear and tear, net rents and energy costs. The modeled percentage cost associated with green new construction features could remain constant or grow through time. Tables I and II results assume energy and water expenses remain a constant percentage over the 15-year period. The agency costs associated with obtaining a LEED or BREEAM certification was not calculated as an upfront cost. Certification by LEED or BREEAM increases the upfront cost associated with building a green building.Practical implications– The length of the payback period estimates coupled with negative NPV for green certified compared to non-green construction suggests that developers do not have an incentive to build green. Higher WACC rates would result in green-certified projects being less feasible to build.Social implications– The LEED certification point system may need to be reviewed. Points are assigned for features that improve occupant satisfaction, but may have little impact on reducing energy usage.Originality/value– A model is presented for determining whether green-certified construction is financially feasible. The model enables the investor to determine the size of a tax incentive that is needed to enable new green construction to be economically feasible to build. The higher the negative NPV the larger the income or property tax incentive or other financial incentives needed. Prior research studies compared green and non-green buildings, but did not compare the energy savings generated to the additional construction and upfront costs incurred using a discount rate. They assumed the energy savings justified the additional initial cost associated with building a new green certified.