Question: Question 4) You come across a small office building for sale with an asking price of $400,000. After careful analysis, you estimate that you'll receive
Question 4) You come across a small office building for sale with an asking price of $400,000. After careful analysis, you estimate that you'll receive $46,000 in annual profit before financing.
For each part of this question, show your work with the help of a table.
We strongly recommend you complete calculations for this question in Excel (since you can reuse your work). To assist you with this, we've published the Excel Template for calculating the Benefits and Risks of Financial Leverage from Lecture 7 below:
| Project Value | $ 1,000,000 |
| Annual Profit Before Financing | $ 110,000 |
| Return on Assets (ROA) | 11.00% |
| Source of Capital | |
| Loan-to-Value | 0% |
| Loan Amount | $ - |
| Equity | $ 1,000,000 |
| Financing Costs | $ - |
| Annual Profit After Financing | $ 110,000 |
| Return on Equity (ROE) | 11.00% |
Q4(a). What is your projected Return-on-Assets for this investment? Q4(b). After talking with your lender, you find you can easily borrow 60% of the property's purchase price. Interest and fees related to the loan will cost you $14,000 per year.
What is your projected Return-on-Equity for this investment?
Show your Annual Profit After Financing calculation by constructing a table as seen in the "Benefits of Financial Leverage" discussion in lecture.
In addition, show your work (i.e. the formula you would use) for calculating projected Return-on-Equity. Q4(c).Being a savvy investor, you want to find out what would happen if there is downturn in the market. In the event of a market downturn, you estimate the annual profit before financing would be negative $10,000.
What would the Return-on-Assets for this investment be in the event the market downturn above?
Show your work. Q4(d). Under the same assumptions as Q4(c), what would the Return-on-Equity for this investment be?
Show your Annual Profit After Financing calculation by constructing a table as seen in the "Risks of Financial Leverage" discussion in lecture.
In addition, show your work (i.e. the formula you would use) for calculating projected Return-on-Equity. Q4(e). What do the two cases above tell us about the effect of leverage on real estate investments?
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