Marchant/Fall 2008 FINANCIAL LEVERAGE EXERCISE (EXAMPLE) Assume the Return on Total Asset (ROTA) for Brookridge Apartments is 10% based upon the following calculation: ROTA = NOI divided by TAC NOI = $456,306 TAC = $4,563,060 Therefore, ROTA = $456,306 divided by $4,563,060 = 10% Annual Constant 9% (Therefore, positive leverage because Annual Constant is lower than ROTA) $456,306 1.15 $396,788 10% (Therefore, "neutral" leverage because Annual Constant is the same as ROTA) $456,306 1.15 $396,788 12% (Therefore, negative leverage because Annual Constant is higher than ROTA) $456,306 1.15 $396,788
NOI Debt Service Coverage Factor (DSCF) Funds Available for Debt Service (NOI divided by DSCF) Maximum Supportable Loan (Funds Available for Debt Service divided by Annual Constant) Debt Service Payment (Maximum Supportable Loan multiplied by Annual Constant) Before Tax Cash Flow (BTCF) (NOI minus Debt Service Payment) Equity (TAC minus Maximum Supportable Loan) Cash-on-Cash Return (BTCF divided by Equity)
$4,408,755
$3,967,880
$3,306,567
$396,788
$396,788
$396,788
$59,518
$59,518
$59,518
$154,305
$595,180
$1,256,493
38.57%
10.00%
4.74%
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Complete the calculations for the following shaded cells based upon the respective Annual Constants: Annual Constant 8% (Therefore, positive leverage because Annual Constant is lower than ROTA) $456,306 1.15 $396,788 11% (Therefore, negative leverage because Annual Constant is the same as ROTA) $456,306 1.15 $396,788 13% (Therefore, negative leverage because Annual Constant is higher than ROTA) $456,306 1.15 $396,788
NOI Debt Service Coverage Factor (DSCF) Funds Available for Debt Service (NOI divided by DSCF) Maximum Supportable Loan (Funds Available for Debt Service divided by Annual Constant) Debt Service Payment (Maximum Supportable Loan multiplied by Annual Constant) Before Tax Cash Flow (BTCF) (NOI minus Debt Service Payment) Equity (TAC minus Maximum Supportable Loan) Cash-on-Cash Return (BTCF divided by Equity)
$396,788
$396,788
$396,788
$59,518
$59,518
$59,518
Explain why Cash-on-Cash return is enhanced by positive leverage and diminished by negative leverage.
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FINANCIAL LEVERAGE EXERCISE (ANSWERS) Annual Constant 8% (Therefore, positive leverage because Annual Constant is lower than ROTA) $456,306 1.15 $396,788 11% (Therefore, negative leverage because Annual Constant is the same as ROTA) $456,306 1.15 $396,788 13% (Therefore, negative leverage because Annual Constant is higher than ROTA) $456,306 1.15 $396,788
NOI Debt Service Coverage Factor (DSCF) Funds Available for Debt Service (NOI divided by DSCF) Maximum Supportable Loan (Funds Available for Debt Service divided by Annual Constant) Debt Service Payment (Maximum Supportable Loan multiplied by Annual Constant) Before Tax Cash Flow (BTCF) (NOI minus Debt Service Payment) Equity (TAC minus Maximum Supportable Loan) Cash-on-Cash Return (BTCF divided by Equity)
$4,959,848
$3,607,163
$3,052,215
$396,788
$396,788
$396,788
$59,518
$59,518
$59,518
($396,788)
$955,897
$1,510,845
Infinite (No Equity Required)
6.23%
3.94%
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