Answer:
Net operating income:
It reflects the profitability of real estate investment. It examines the cash flow of investment property before the factors such as taxes and finance costs. The difference between all the operating expenses and the revenue generated by particular property is estimated as the Net Operating Income.
a.
Value of property after
year:
Value of property after five years can be calculated with the help of growth rate.
Value of apartment is
, apartment is sold after
year, and growth rate is
.
Write the expression to calculate the value of property.
Here,
is the current value of property,
is the growth rate, and
is the number of year.
Substitute
for
,
for
, and
for
.
Hence, the value of property after
year is
.
Interest per annum when loan is
financing:
Interest paid per annum can be calculated with the help of interest rate and proportion of loan.
Proportion of loan is
, and interest on loan is
.
Write the expression to calculate the interest per annum.
Substitute
for value of property,
for proportion of loan, and
for interest rate.
Hence, the interest per annum is
.
Computation of before tax internal rate of return:
Before tax internal rate of return can be computed with the help of net cash flows at each year.
Expected net operating income in first year is
, and expected growth rate for net operating income is
.
Calculation of IRR is given in below excel.
The resultant figure from the excel sheet is given below.
Hence, the before tax internal rate of return (BTIRR) is
.
Computation of after-tax internal rate of return:
After tax internal rate of return can be computed with the help of net cash flows at each year.
Calculation of IRR is given in below excel.
The resultant figure from the excel sheet is given below.
Hence, the after-tax internal rate of return (ATIRR) is
.
Interest per annum when loan is
financing:
Interest paid per annum can be calculated with the help of interest rate and proportion of loan.
Proportion of loan is
, and interest on loan is
.
Write the expression to calculate the interest per annum.
Substitute
for value of property,
for proportion of loan, and
for interest rate.
Hence, the interest per annum is
.
Computation of before tax internal rate of return:
Before tax internal rate of return can be computed with the help of net cash flows at each year.
Expected net operating income in first year is
, and expected growth rate for net operating income is
.
Calculation of IRR is given in below excel.
The resultant figure from the excel sheet is given below.
Hence, the before tax internal rate of return is
.
Computation of after-tax internal rate of return:
After tax internal rate of return can be computed with the help of net cash flows at each year.
Calculation of IRR is given in below excel.
The resultant figure from the excel sheet is given below.
Hence, the after-tax internal rate of return is
.
b.
Break even interest rate:
Break-even mortgage rate refers to that rate at which financial leverage does not fetch any benefit to the investor. The rise of the mortgage rate above the break-even mortgage rate causes financial leverage to fetch negative returns.
On the other hand, if mortgage rate falls below the break-even mortgage rate, then financial leverage will fetch positive returns.
Break even interest rate is the rate is calculated by after tax IRR divided by one minus tax rate. Break even interest rate in case of 70% loan is calculated below:
Hence, the break-even interest rate is
.
Break even interest rate in case of 80% loan is calculated below:
Hence, the break-even interest rate is
.
c.
Marginal cost:
The increase or decrease in the collective cost of a production run for making one extra unit of a thing. It is registered in circumstances where the breakeven point has been achieved. The fixed expenses have just been consumed by the units already produced and the variable costs must be represented.
Marginal cost for
loan:
Marginal cost can be computed with the help of interest rate charges on both loans.
Write the expression to calculate the marginal cost.
Substitute
for interest rate on
loan, and
for interest rate on
loan.
Hence, the marginal cost for
loan is
.
d.
Financial Leverage:
The benefit that an investor receives from the use of debt is known as financial leverage. Benefit from use of financial leverage arises when rate of interest paid by the investor on the borrowed amount is lower than the rate of return received from the investment. The return on the equity of the investor is enlarged by the use of financial leverage.
Whether each loan offers favorable financial leverage:
When investor selects the
loan financing, investor will get
before tax internal rate of return and if investor selects
loan financing then the investor will get
before tax internal rate of return.
And if, investor selects the
loan financing, investor will get
after tax internal rate of return and if investor selects
loan financing then investor will get
after tax internal rate of return.
Hence, the only loan that offers favorable financial leverage is
loan.
Answer:
Participation loan:
It is a kind of loan in which lender participates in the net operating income. To participate in the net operating income lender lowers the interest rate. In return, borrower lets lender have some part of his income. In this, lender becomes a type of equity partner instead of debt provider.
The reason for which a lender prefer loan with a lower interest rate and participation:
The loan with participation is given significance by a lender and also lower interest rate is given importance as it evades against inflation. Net operating income and the resale value moves in same way as inflation. So, if the inflation rises, the rise in net operating income will compensate the loss of purchasing power of money. The lender also does not require participating in losses.
Hence, a lender prefers loan with lower interest rate and participation because participation loan acts as hedge against inflation.
Answer:
Participation loan:
It is a kind of loan in which lender participates in the net operating income. To participate in the net operating income lender lowers the interest rate. In return, borrower lets lender have some part of his income. In this, lender becomes a type of equity partner instead of debt provider.
The way in which participation affects the riskiness of the loan:
Participation loan have lower rate of interest than rate of interest in loan without participation. Participation loan also provides some part of the cash inflow to the lender. In the time of inflation, cash inflow rises, which lead to rise in cash inflow for lender. So, it reduces the risk for lender, as participation loan guards the lender against unexpected inflation.
It also reduces the risk for investor, as investor has to pay less fixed payment. In the event of less cash inflow or no cash inflow, the investor has to make lower payment because of the low interest rate.