Reference no: EM131406206

Problem 1

If total return after tax on a certain project is 7.5%, and there are five financing choices available to investors:

(1) 7% interest rate and a 60% LTV ratio;
(2) 7.8% interest rate and a 70% LTV ratio;
(3) 8.5% interest rate and a 80% LTV ratio;
(4) 9.25% interest rate and a 90% LTV ratio;
(5) 9.75% interest rate and a 95% LTV ratio;

Suppose that there are three types of investors (A, B and C) whose tax rates are 15%, 25%, and 35%, respectively.

Questions:

(1) Find out the financing choice for each type of investor and the corresponding after-tax return on equity.
(2) Which type of investor has the highest after-tax return on their equity?

Problem 2

A real estate investor has the following information on an apartment building:

Purchase Price is $1,125,000 with acquisition costs of $35,000
33,600 leasable square feet

Initial rent of $1.5/sq. ft. per month and will increase at the beginning of each year for 5 percent per year. For example, the first year rent from month 1 to month 12 is $1.5/sq. ft., the 2nd year rent from month 1 to month 12 is $1.575 ($1.5*(1+5%)), and so on.
Vacancy rate of 5% of gross rent per month.

Operating expenses are 25% of effective gross income

Three financing choices:

1. Mortgage with 75% LTV ratio, 20 years, monthly payments and 5% annual rate;

2. Mortgage with 80% LTV ratio, 20 years, monthly payments and 6% annual rate;

3. Mortgage with 85% LTV ratio, 20 years, monthly payments and 6.5% annual rate;

Holding period is 3 years (36 months) and the capital improvement expenditure is assumed to be $20,000 at the end of the first year only (12 months).

Expected increase in value is 50% in total when sold in year 3 (36 months), 5% selling expenses
75% depreciable with monthly depreciation.
Investor's tax rate is 35%, and capital gain tax rate is 15%.

Questions:

1. Compute equity after-tax cash flows from month 1 to month 36 for each financing choice.

2. What is the equity after-tax annual return (internal rate of return) for each financing choice and which choice would you like to make?