Question

Question #3 Setup: You come across a small office building for sale with an asking price of $400,000. After careful analysis, you estimate that you’ll receive $26,000 in cash flow from operations during the year (after all expenses) plus a 5.00% appreciation of the value of the property. For each part of this question, show your work with the help of a table. We strongly recommend you complete your calculations for this question in Excel (since you can reuse your work). To assist you with this, we’ve published the Excel Template for calculating the Benefits and Risks of Financial Leverage from Lecture 7 below: Click Here to Download the Excel Template with the Example from ClassPreview the documentView in a new window Project Value $1,000,000 Cash Flow from Operations $80,000 Appreciation Rate 3.00% Appreciation $30,000 Profit Before Financing Expenses $110,000 Source of Capital Loan-to-Value 50% Loan Amount $500,000 Equity $500,000 Finacing Costs $30,000 Profit After Financing Expenses $80,000 To make your life easier, please review the information on copying and pasting tables from Excel into Canvas, please see Lecture 0.3: Working with Table and Equations in Canvas. As a reminder, to copy and paste tables from Excel into Canvas, please follow the steps below: Zoom out on your browser window to 100% or whichever size that will accommodate the table. Increase the size of your answer box, so the entire table will be visible to you. Copy your table from Excel and Paste into the Canvas Answer Box. Select All (CTRL A) and adjust the Font to size 8pt Add a Border Format the text to match the table you copied Finally, be sure to follow the guidelines for “Showing Your Work” under Lecture 0.2: Completing Assignments in Canvas when you are asked to “show your work” in calculating Return on Assets or Return on Equity (show us the equation you’re using). 3(a). What is your projected Return-on-Assets for this investment? Use a table to show your financial analysis. In addition, show your work for calculating projected Return-on-Assets. 3(b). After talking with your lender, you find you can easily borrow 60% of the property’s purchase price. Interest and fees related to the loan will cost you $14,000 per year. What is your projected Return-on-Equity for this investment? Use a table to show your financial analysis. In addition, show your work for calculating projected Return-on-Equity. 3(c). Being a savvy investor, you want to find out what would happen if there is downturn in the market. In the event of a market downturn, you estimate the cash flow from operations generated by the property would be only $6,000 and you estimate the property’s value would decreases by 4.0%. What would the Return-on-Assets for this investment be in the event the market downturn above? Use a table to show your financial analysis. In addition, show your work for calculating Return-on-Assets 3(d). Under the same assumptions as Q3(c), what would the Return-on-Equity for this investment be? Use a table to show your financial analysis. In addition, show your work for calculating Return-on-Equity. 3(e). What does the relationship between ROA and ROE in the two cases above tell us about the effect of leverage on real estate investments?

Answer 1

Hey there !

This question is related to claculation of return on assets and return on equity...let me help you calculate the same....

Now, lets list down the given points of the question in a simplified manner...

Answer 3a

Projected return on Assets for Investment of $1000,000

	Particulars	Amount
	Cash flow from Operations	80,000
Add	Appreciation in value of property	30,000
	Profit before financing expenses	1,10,000
Less	Financing Cost	30,000
A	Profit After financing expenses	80000
B	Project Value	10,00,000
Ans 3a	Return on Assets = Net Income/ Total Assets (A/B)	8%

Answer 3b Now let us find Return on equity on project 2

	Particulars	Amount
	Cash flow from Operations	26,000
Add	Appreciation in value of property	20,000
	Profit before financing expenses	46,000
Less	Financing Cost	14,000
A	Profit After financing expenses	32,000
	Project Value	4,00,000
	Financed through Loan (4L * 60%)	2,40,000
B	Balance through Equity	1,60,000
Ans 3b	Return on Equity = Net Income/ Total Equity (A/B)	20%

Answer 3c In case of event of Market turndown, our return on net assets will be negative...let us see how this is affected...

	Particulars	Amount
	Cash flow from Operations	6,000
Add	Depreciation in value of property (4% of 400,000)	-16,000
	Profit before financing expenses	-10,000
Less	Financing Cost	-14,000
A	Profit After financing expenses	-24,000
B	Project Value	4,00,000
	Financed through Loan (4L * 60%)	2,40,000
	Balance through Equity	1,60,000
Ans 3c	Return on Net assets = Net Income/ Total Assets (A/B)	-6%

Answer 3 D Again, the return on rquity will be negative...let us see how

	Particulars	Amount
	Cash flow from Operations	6,000
Add	Depreciation in value of property (4% of 400,000)	-16,000
	Profit before financing expenses	-10,000
Less	Financing Cost	-14,000
A	Profit After financing expenses	-24,000
	Project Value	4,00,000
	Financed through Loan (4L * 60%)	2,40,000
B	Balance through Equity	1,60,000
Ans 3d	Return on equity = Net Income/ Total equity (A/B)	-15%

I hope the solution is clear to you....do let me know if you have any concerns...happy studying !! All the best !!