Question

You have an opportunity to acquire a property from First Capital Bank. The bank recently obtained the property from a borrower who defaulted on his loan. First Capital is offering the property for $200,000. If you buy the property you will have to (1) spend $10,500 on various acquisition related expenses and (2) exactly $2,000/month during the next 12 months for repairs in order to prepare for sale. Because First Capital Bank would like to sell the property as soon as possible, it is willing to provide 90% LTV mortgage at 8% for one year interest only. You believe the property will sell for $270,000 at the end of one year. You will incur a 6% in selling costs.

a) What is you expected annual return on this investment?

b) Is this a good investment and why?

c) What counter offer would you consider making First Capital and why?

Answer 1

a) What is you expected annual return on this investment?

Ans : Minimum Expected Return would be 8%. (ie, Cost of sourcing funds is 8%)

b) Is this a good investment and why?

Ans: Return from the investment is Positive (+4900) So investment is good

workings

Property Sale Value 2,70,000

'- Selling Costs @6% on Sale Value -16,200

Net Sale Proceds (A) 2,53,800

Cost of property upto sale

Cost Acquistion 200,000

Expenses after acquisition 10,500

Repairs of 12 Months @2000 24000

Loan Intrest due to martgage

Loan value (90% on Value) 180,000

Interest for 1 Year@8% 14,400

Cost of property upto sale ( B) 2,48,900

Return on investment (A-B) +4900

c) What counter offer would you consider making First Capital and why?

Calculation of Min & Max Values of offer

Max price ( 200,000-4900) =1,95,100

Min Offer (200,000 -200,000*8%) =1,84,000

Notes :

1) Time value of Money Ignored

2) Other Cost are incurred uisng own funds & Notional intreste has not considered