An investor would like to purchase a new apartment property that costs $2 million with an initial year NOI of $190,000, and an expected growth rate of 3% per year (in income and value).
The building and improvements represent 80% of value and will be depreciated over (1 + 27.5 per year). Assume a 36% tax bracket for all income and capital gains taxes.
The investor faces the decision of whether to use 70% or 80 % financing. The 70% loan can be obtained at 10% interest for 25 years. The 80% loan can be obtained at 11% interest for 25 years.
Develop a 10-year pro forma.
(a) Use the pro forma to determine the before-tax IRR (BTIRR) and after-tax IRR (ATIRR) for each level of financing (assume monthly mortgage amortization).
(b) What is the break-even interest rate (BEIR) for this project?
(c) What is the marginal cost of the 80% loan? What does this mean?
(d) Does each loan offer favorable financial leverage? Which would you recommend?
An investor would like to purchase a new apartment property that costs $2 million with an initial year NOI of $190,000, and an expected growth rate of 3% per year (in income and value).
The building and improvements represent 80% of value and will be depreciated over (1 + 27.5 per year). Assume a 36% tax bracket for all income and capital gains taxes.
The investor faces the decision of whether to use 70% or 80 % financing. The 70% loan can be obtained at 10% interest for 25 years. The 80% loan can be obtained at 11% interest for 25 years.
Develop a 10-year pro forma.
(a) Use the pro forma to determine the before-tax IRR (BTIRR) and after-tax IRR (ATIRR) for each level of financing (assume monthly mortgage amortization).
(b) What is the break-even interest rate (BEIR) for this project?
(c) What is the marginal cost of the 80% loan? What does this mean?
(d) Does each loan offer favorable financial leverage? Which would you recommend?
Related questions
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:
| Sales | $ | 6,400,000 |
| Variable costs (50% of sales) | 3,200,000 | |
| Fixed costs | 1,940,000 | |
| Earnings before interest and taxes (EBIT) | $ | 1,260,000 |
| Interest (10% cost) | 480,000 | |
| Earnings before taxes (EBT) | $ | 780,000 |
| Tax (40%) | 312,000 | |
| Earnings after taxes (EAT) | $ | 468,000 |
| Shares of common stock | 340,000 | |
| Earnings per share | $ | 1.38 |
The company is currently financed with 50 percent debt and 50 percent equity (common stock, par value of $10). In order to expand the facilities, Mr. Delsing estimates a need for $3.4 million in additional financing. His investment banker has laid out three plans for him to consider:
Sell $3.4 million of debt at 10 percent.
Sell $3.4 million of common stock at $20 per share.
Sell $1.70 million of debt at 9 percent and $1.70 million of common stock at $25 per share.
Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,440,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.70 million per year for the next five years.
Delsing is interested in a thorough analysis of his expansion plans and methods of financing.He would like you to analyze the following:
a. The break-even point for operating expenses before and after expansion (in sales dollars). (Enter your answers in dollars not in millions, i.e, $1,234,567.)
b. The degree of operating leverage before and after expansion. Assume sales of $6.4 million before expansion and $7.4 million after expansion. Use the formula: DOL = (S â TVC) / (S â TVC â FC). (Round your answers to 2 decimal places.)
c-1. The degree of financial leverage before expansion. (Round your answers to 2 decimal places.)
c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $7.4 million for this question. (Round your answers to 2 decimal places.)
d. Compute EPS under all three methods of financing the expansion at $7.4 million in sales (first year) and $10.3 million in sales (last year). (Round your answers to 2 decimal places.)
