Exam (elaborations)
REE5305 CH 12 (1)
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Exam of 2 pages for the course REE 5305 at REE 5305 (REE5305 CH 12 (1))
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REE5305 CH 12Financial leverage is defined as benefits that may result to an investor by borrowing money at a
rate of interest that is lower than the expected rate of return on total funds invested in a property.
- ANS-True
One advantage of using leverage is that NOI increases with higher amounts of leverage. -
ANS-False
An interest-only loan will provide a higher debt coverage ratio than an amortizing loan with the
same interest rate. - ANS-True
A property is financed with a 75 percent loan at 11.5 percent over 25 years. The property
produces an ATIRR on total investment of 7.34 percent based on a tax rate of 31 percent. What
can be said about the leverage associated with the property? - ANS-Negative Leverage exists
(BTIRR = (0.0734/(1 − 0.31)) = 0.1064, or 10.64%)
All other things being equal, which of the following best describes the effects of leverage on an
investment's risk-return characteristics (assuming the expected return is greater than the
lending rate)? - ANS-Higher Average return, Higher risk
An investment has the following characteristics:
ATIRRP: After-tax IRR on total investment in the property: 9.0%
BTIRRE: Before-tax IRR on equity invested: 17%
BTIRRP: Before-tax IRR on total investment in the property: 12%
t: Marginal tax rate: 0.40
What would be the break-even interest rate (BEIR) at which the use of leverage is neither
favorable nor unfavorable? - ANS-15% (BEIR = (ATIRRP / (1 − t)) = (0.09 / (1 − 0.4)) = 0.15, or
15%)
A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a
property is $60,000, what is the maximum amount of debt service the lender would allow? -
ANS-$50,000 (($60,000/1.2) = $50,000)
A property produces an 8.92 percent ATIRR on the total investment considering a tax rate of 28
percent. What is the maximum interest rate that could be paid on debt without causing the
leverage to be negative? - ANS-12.39% (8.92%/(1 − 28%) = 12.39%)
A loan in which the lender receives a percentage of the net operating income from the property
is known as a(n): - ANS-Particpation Loan
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