A property has 21,000 squarefeet of rental space. The vacancy and credit losses

Question

A property has 21,000 squarefeet of rental space. The vacancy and credit losses is expected at 8% and operating cost (without capital cost allowance) is 28 percent of effective gross income. Financing details for this property is as follows: down payment is 25%; the property value is $400,000; Interest rate is 11% per annum compounded semi-annually; term of loan is 12 years. The cost of the down payment is 5.80% above the effective cost of borrowing and 50% of the capital gains is taxed. What is the weighted cost of capital if the tax rate is 40%; there are no processing fees and you have cash on hand?

Explanation / Answer

Since interest rate is 11% per annum compunded semi-annually,

Effective Cost of Borrowing = (1 + 11%/2)2 - 1 = 1.113025 - 1 = 11.3025%

Cost of Down Payment = 11.3025% + 5.8% = 17.1025%

Weighted Cost of Capital

        = Weight of Borrowing * Effective Cost of Borrwoing + Weight of Down Payment * Cost of Down payment

        = 0.75 * 11.3025% + 0.25 * 17.1025% = 12.75%

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