An investment opportunity having a market price of $1,000,000 is available. Your
ID: 2825564 • Letter: A
Question
An investment opportunity having a market price of $1,000,000 is available. Your expectation includes these: first-year gross potential income of $300,000; vacancy and collection losses equal to 15 percent of gross potential income; operating expenses equal to 45 percent of effective gross income; and capital expenditures equal to 10 percent of effective gross income. You could obtain a $800,000, 30-year mortgage loan requiring equal monthly payments with interest at 7.5 percent. For the first year only, determine the: a. Net operating income (2.25 pts) b. Effective gross income multiplier (3.25 pts) c. Operating expense ratio (including CAPX) (3.25 pts) d. Monthly and annual payment (3.25 pts) e. Debt coverage ratio (3.25 pts) f. Debt yield ratio (3.25 pts) g. Overall capitalization rate (3.25 pts) h. Equity dividend rate (3.25 pts)
Explanation / Answer
(a) Net operating income
Gross potential income for 1st year = $ 300000
Vacancy and collection losses = 15% of Gross potential income
= 15% ($ 300000)
= $ 45000
Effective gross income = Gross potential income – Vacancy and collection losses
= $ 300000 - $ 45000
= $ 255000
Operating expenses = 45% of effective gross income
= 45% ($ 255000)
= $ 114750
Net operating income = Effective gross income (Gross potential income – Vacancy and collection losses) – Operating expenses
= $ 255000 - $ 114750
= $ 140250
(b) Effective gross income multiplier
Effective gross income multiplier = Sale price / Effective gross income
= $ 800000 / $ 255000
= 3.137254
(c) Operating expense ratio (including CAPX)
Operating expenses ratio = Operating expenses (including CAPX) / Gross operating income
= ($ 114750 + $ 25500) / $ 300000
= 0.4675
(d) Monthly and annual payment
Loan amount = $ 800000
Interest rate = 7.5%
Monthly rate = 7.5/12 = 0.625% per month
Tenure = 30 years
EMI (Monthly payment) = {P*R*(1+R)^N} / {(1+R)^N-1}, where P=principal, R=rate of interest & N=tenure
= $800000*0.625%*(1+0.625%)^30 / {(1+0.625%)^30-1}
= $800000*0.625%*1.20552661024/ {(1.20552661024-1}
= $ 29327.75
Annual payment = Monthly payment * 12
= $29327.75 * 12
= $ 351933
(e) Debt coverage ratio
Debt coverage ratio = Net operating income / debt service
= $ 140250 / $ 800000
= 0.1753
(f) Debt yield ratio
Debt yield ratio = Debt coverage ratio multiplied by 100%
= 17.53%
(g) Overall capitalisation rate = Net Operating Income / Investment value
= $ 140250 / $ 1000000
= 0.14025
(h) Equity dividend rate = Equity Investment / cash flows before tax
Cash flows before tax = Net operating income – (Annual payment for mortgage loan + Capital expenditures)
= $ 140250 – ($ 351933 + $ 25500)
= - 237183
Equity dividend rate = $ 100000 / - $ 237183
= - 4.21
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