1. You have $4m to invest and able to purchase a $4m apartment building entirely
ID: 2779542 • Letter: 1
Question
1. You have $4m to invest and able to purchase a $4m apartment building entirely with cash. You anticipate you can sell the building for $6mm next year and a lender has offered a $3mm IO loan at 10% to purchase the property. Calculate your overall return to the $4mm you if you could alternatively invest the equity in an alternative asset with a 8% return. Should you accept loan?
2. You are thinking about a standard residential $300,000 30year FRM loan at 5.4% with 1 point of origination fees. a. What is the monthly payment and APR of this loan? What is balance after 12 payments? b. What is the effective borrowing cost (EBC) of this loan if you intend to move in 4 years? c. Given you intend to move in 4 years, should you instead originate a $300,000 30year FRM loan offered at 5.16%, but with 2 points of origination fees? Why or why not? d. Given you still intend to move in 4 years, how should you decide between the above loans and a $300,000 15year FRM loan @ 4.8% and 1 point in fees?
3. You have been offered a $500k 7/1 Hybrid ARM Loan with 1pt in origination fees, teaser of 4.8%, margin of 289bp, and future composite rates indexed to LIBOR, which was 3.24% at the time of origination. What is the APR of this loan with and without a 100bp periodic cap?
Explanation / Answer
Answer to Question 1
Amount available in hand = $4 million
Alternative 1:
Sale value of property after one year = $6 million
Retur from the property = 6-4 = $2 million
Rate of return = 2/4*100 = 50%
Alternative 2
Use finance of $3 million at 10% cost and $1 million to by the property
Use the surplus $3 million cash to invest in equity @ 8%
Sale proceeds from property = $6 million
Cost and finance charges = $1 million + $3 million + ($3 million*10%) = $4.3 million
Gain from sale of property = $1.7 million
Return from equity = $3 million * 8% = $0.24 million
Assume that the amount invested in equity is redeemed at par = $3 million
Total return from equity = $3.24 million
rate of return = ((3.24*3/4)+(1.7*1/4))/4 *100 = 71.375%
opting for the loan and investing yeild more return
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