“So you see,” said Roscoe, “I need a loan for $800,000.” Roscoe Lefever was talk
ID: 2821244 • Letter: #
Question
“So you see,” said Roscoe, “I need a loan for $800,000.” Roscoe Lefever was talking to Nancy Berger, the business loan officer at Local Community Bank. Roscoe and Nancy were reviewing Roscoe’s business plan for a new restaurant he wanted to open. “Yes,” replied Nancy. “I see the total project cost is $850,000. And you have $50,000 of that.” “That’s right,” said Roscoe. “$40,000 from my savings and $10,000 that I borrowed from my folks.” “I see that,” said Nancy. “And your financial projections are that the restaurant will have annual sales of $1,000,000 with an after-expense NOI of $100,000. With $70,000 of that desig- nated for debt repayment.” “That’s right,” replied Roscoe. “Is that a problem?” “It’s not a problem if you hit those numbers,” replied Nancy, “but have you thought about what you’ll do if you don’t hit them?”
1. Assume Roscoe’s projections are accurate. What would be the debt coverage ratio result- ing from an $800,000 loan that required repayments of $70,000 per year?
2. What would be Roscoe’s equity rate of return? If you were Nancy, would you make the loan? Explain your answer.
Explanation / Answer
1) Debt coverage ratio= Operating Income/Debt repayment per year
Operating income=NOI=$100,000
Debt repayment =$70,000
Debt coveerage ratio= 100,000/70,000=1.43
2)
Equity rate of return = NOI-debt repayment/Equity invested
Equity invested = 50,000
return = 100,000-70,000=30,000
Equity return = 30,000/50,000=0.60 or 60% ( All these calculations have excluded tax as there is no information about tax)
If I were in place of Nancy I would make the loan subject to few conditions. Those conditions being that the cash flows as estimated have a very high chances of being realized. Also I would make sure that Mr. Roscoe has enough expertise in his business so that the cash flows are realized.
The reason for approving the loan are that there is enough cash flow of $100,000 to repay debt of $70,000 per year.
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