An investor would like to purchase a new apartment property for $2mm. However, she faces the decision of whether to use 70 percent versus 80 percent financing. The 70 percent loan can be obtained at 10 percent interest for 25 years. The 80 percent loan can be obtained at 11 percent interest for 25 years. NOI is expected to be $190,000 per year and increase at 3 percent annually, the same rate at which the property is expected to increase in value. The building and improvements represent 80 percent of value and will be depreciated over 27.5 years (1/27.5). The project is expected to be sold after five years. Assume a 36 percent tax bracket for all income and capital gains taxes.
a. What would be the BTIRR and ATIRR at each level of financings (assume monthly mortgage amortization)?
b. What is the break-even interest rate (BEIR) for this project?
c. What is the marginal cost of the 80 percent loan? What does this mean?
d. Does each loan offer favorable financial leverage? Which would you recommend and why?