A property is offered for $650,000, $409,000 of which is financed through a firs

Question

A property is offered for $650,000, $409,000 of which is financed through a first mortgage note. The following data reflect the expected first-year operating results: Potential gross rent $150,000 Less: Vacancy and uncollectible rent 8,000 Effective gross income $142,000 Less: Operating expenses 80,000 Net operating income $62,000 Less: Debt service 50,000 Before-tax cash flow $12,000 Plus: Principal paid 1,600 Less: Cost recovery allowance 18,000 Taxable income (loss) ($5,000) Times: Marginal income tax rate (federal and state) .40 Income tax (tax savings) ($2,000) Before-tax cash flow $12,000 Plus: Tax savings 2,000 After-tax cash flow $14,000 Required: Based on the above forecast, compute: I. The potential gross income multiplier; II. The operating ratio; III. The debt coverage ratio; IV. The overall capitalization rate; V. The cash-on-cash rate of return.

Explanation / Answer

Potential Gross Multiplier = Market price / Effective gross income Potential Gross Multiplier = 650000 / 142000 = 4.58 Opearating ratio = Operating expenses / Effective gross income Opearating ratio = 80000 / 142000 = .5634 or 56.38% Debt Coverage Ratio = NOI / Annual debt Debt Coverage Ratio = 62000 / (50000 + 1600) Debt Coverage Ratio = 1.20 Overall capitalization rate = NOI / Market price   Overall capitalization rate = 62000 / 650000 = .0954 or 9.54% Cash on cash rate of return = Annual income Before Tax / Total amount Invested Cash on cash rate of return = 12000 / 650000 = 0.0185 or 1.85%

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