Question

Discuss how the change in the Debt service changed analysis (i.e. how did it change the property value, the going-in cap rate and the equity dividend rate)?

Answer 1

Answer-

Debt service includes interest and principal amount paid in any year for the loan obtained. This is the payment that is made annually, semuannually or monthly (EMIs).

The overall property value can be reduced by paying the amount in less duration of time. Taking a loan for 5 years increases the EMIs but the overall payments amount reduces rather than taking the loan for 7 years which has lesser EMIs but higher overall payment amount. The debt service changed analysis is effected accordingly.

Going-in-cap rate is the cap rate is evaluated by the ratio of the first year of net operating income for the property purchase price. The higher cap rate means higher risk investment whereas lower cap rate means an investment is of lower risk.

Equity Dividend Rate = Equity Investment ÷ Before Tax Cash Flow. This depends on the equity and debt that is used in debt structure. The debt service changed analysis is effected in the way that the hoigher equity in the capial structure increases the risk and increases the WACC which increases the amount or cashflows to be paid as it uses a higher WACC or discount rate.