Question

You are an employee of University Consultants, Ltd and have been given the following information. You are to present an investment analysis of a new small income-producing property for sale to a potential inventor. The asking price for the property is $8.5 million. You determine that the building was worth $7.225 million and could be depreciated over 39 years (use 1/39 per year). NOIs are estimated to be $901,375 for year 1, $900,681 for year 2, $899,962 for year 3, $943,700 for year 4, $961,855 for year 5 and expected to increase by 3.16% thereafter. A fully amortizing 70 percent loan can be obtained at 10 percent interest for 20 years (total annual payments will be monthly payments *12). The property is expected to be sold for $9,360,805 after 5 years. Capital gains from price appreciation will be taxed at 15 percent and depreciation recapture will be taxed at 25 percent. Your ordinary income will be taxed at 35 percent. Assume that there is no selling cost and equity discount rate is 13%.

a. What is mortgage loan balance by the end of year 5?

b. What is the annual interest dollar amount in year 2?

c. What is the debt service for year 4?

d. What is the first-year debt coverage ratio?

e. What is the first-year equity dividend rate?

Answer 1

a) Outstanding mortgage loan balance at the end of year 1 is $4.569 million

Years	Mortgage Balance at the start of the year	Annual EMI	Interest	Principal Payment	Mortgage Balance at the end of the year
1	5,057,500	585,672	505,750	79,922	4,977,578
2	4,977,578	585,672	497,758	87,914	4,889,665
3	4,889,665	585,672	488,966	96,705	4,792,959
4	4,792,959	585,672	479,296	106,376	4,686,584
5	4,686,584	585,672	468,658	117,013	4,569,570

b) From the above table, we can see the annual interest amount is $497,758.

c) Debt Service for year 4 is 1.61x
Debt Service Ratio = Net Operating Income/(Interest + Principal Repayment)
= 943700/(479296+106376)
= 1.61x

d) Debt Coverage ratio for year 1 is 1.54x
Debt Service Ratio = Net Operating Income/(Interest + Principal Repayment)
= 901375/(505750+79922)
= 1.54x

e) Equity Dividend Rate is 14.57%

	Year 1
NOI	901,375
Interest	(585,672)
Profit Before Tax	315,703

Equity Dividend Rate = Profit Before Tax/ Equity Investments
= 315,703/ 2,167,500.00
= 14.57%