A building was purchased for $100,000. Suppose the investor intends to sell the
ID: 2641641 • Letter: A
Question
A building was purchased for $100,000. Suppose the investor intends to sell the property after one year for an expected selling price of $108,000 (Thus, there is only a one year holding period.). Suppose the net operating income (NOI) for the year was $7,000. Suppose 60% of the purchase price can be borrowed at 10% annual interest, with the payments being interest-only.
A.) How much higher or lower is the return on equity if the investor purchases the property with 60% debt financing on the above terms than if it is purchased with 100% equity?
B.) What happens to leverage and the return on equity with 60% debt financing if the selling price is only $102,000? Explain why this happens.
Explanation / Answer
ROE WILL BE HIOGHER IF PURCHASE ON 60% FINANCING .ITS ONLY 16% . THAN PURCHASED ON 1005 EQUITY FUNDING .
ROE WILL REDUCED SIGNIFICANTLY AS THE RETURN WILL BE 2%. THE REASON BEING SLELEING REDUCE SIGNIFICANTLY AND COST OF DEBT REMANS HIGH .
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