Queenie Spades has approached the Happy Trust Company to borrow $580,000 through
ID: 2340273 • Letter: Q
Question
Queenie Spades has approached the Happy Trust Company to borrow $580,000 through a second mortgage secured by his office building. The outstanding first mortgage on this property was written 8 years ago for $725,000 at a rate ofi-796. The loan called for level quarterly payments of $16,128.26, sufficient to amortize the principal over the loan term of 22 years. Annual net operating income for this building is $162,700. 13. The Happy Trust Company is willing to make a second mortgage loan at a rate of,-13.5%. This loan requires quarterly payments sufficient to fully amortize the principal over a term of 10 years. The trust company requires a debt coverage ratio for the total of first and second mortgage payments of 1.15 What size loan will Queenie qualify for, given the above conditions? (1) (2) (3) (4) Exactly $580,000 Substantially less than $580,000 Substantially greater than $580,000 Cannot be determined from the information givenExplanation / Answer
Answer:
Correct answer is:
(2) Substantially less than $580,000
Explanation:
Annual net operating income/EBIT = $162,700
Quarterly payment of loan (First Mortgage) = $16128.26
Annual payment = 4 * Quarterly payment = 4 * $16128.26= $64,513.04
Debt Coverage ratio required = 1.15
Maximum annual payments possible for First and second mortgage = EBIT / 1.15 = $162,700 / 1.15 = $141,478. 30
Maximum possible annual payment for second mortgage = Maximum possible annual mortgage payment - Annual payment of first mortgage = $141,478.30 - $64,513.04 = $76,965.22
Maximum possible quarterly payment for second mortgage = Maximum possible annual payment for second mortgage / 4 = $76,965.22 / = $19,241.31
Quarterly interest rate of second mortgage = 13.5%/4
Number of quarterly payments = 10 * 4 = 40
Using excel function for PV:
PV(rate, nper, pmt, fv, type)
PV(13,5%/4, 40, -19241.31, 0, 0)
= $418,986.52
Hence maximum possible loan (on second mortgage) = $418,986.52. This is substantially less than $580,000.
Hence option (2) is correct.
As we calculate above maximum possible loan is $418,986.52 hence options (1), (3) and (4) are incorrect.
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