Mrs. Gladstone is purchasing a Chicago apartment for $1 million one year before the upcoming election....

Transcribed Image Text:

Mrs. Gladstone is purchasing a Chicago apartment for $1 million one year before the upcoming election. If the current mayor is reelected (a 70% probability), the apartment will increase in value by 15%, in her opinion. If the current mayor loses the election (30% probability), the apartment will fall in value by 20%. She considers whether (i) to borrow $800,000 of the purchase price, and invest $200,000 equity (her own money), or (ii) invest $1 million in equity of her own money. The interest rate on debt is 6%. In a default, 5% of the value of the apartment is lost to bankruptcy costs. (There are no rental incomes, operating expenses, or taxes). a. What is her expected equity return under (i) all equity or (ii) debt/equity options with each scenario? b. What is the lenders' expected rate of return under each scenario? Mrs. Gladstone is purchasing a Chicago apartment for $1 million one year before the upcoming election. If the current mayor is reelected (a 70% probability), the apartment will increase in value by 15%, in her opinion. If the current mayor loses the election (30% probability), the apartment will fall in value by 20%. She considers whether (i) to borrow $800,000 of the purchase price, and invest $200,000 equity (her own money), or (ii) invest $1 million in equity of her own money. The interest rate on debt is 6%. In a default, 5% of the value of the apartment is lost to bankruptcy costs. (There are no rental incomes, operating expenses, or taxes). a. What is her expected equity return under (i) all equity or (ii) debt/equity options with each scenario? b. What is the lenders' expected rate of return under each scenario?

Answer rating: 100% (QA)

To calculate Mrs Gladstones expected equity return and the lenders expected rate of return under each scenario we will consider the probabilities asso... View the full answer