Chapter 12

Question 1

Financial leverage is defined as benefits that may result to an investor by borrowing money at a rate of interest that is lower than the expected rate of return on total funds invested in a property.

Answer 1

True

Question 2

One benefit of leverage is that it may allow an investor to diversify across several investment properties.

Answer 2

True

Question 3

One advantage of a sale-leaseback is that the lease payments are 100 percent tax deductible.

Answer 3

True

Question 4

One advantage of using leverage is that NOI increases with higher amounts of leverage.

Answer 4

False

Question 5

Properties with a higher ratio of debt are considered to also have a higher risk assuming everything else is equal.

Answer 5

True

Question 6

If a property owner borrows money at a rate that is higher than the equity yield rate, negative leverage exists.

Answer 6

True

Question 7

Under which conditions would one be MOST LIKELY to see an interest rate swap?

Answer 7

A borrower wants a fixed rate loan, but the bank only offers floating rate loans; the borrower “swaps” loans with someone who has a fixed rate loan

Question 8

A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a property is $60,000, what is the maximum amount of debt service the lender would allow?

Answer 8

$50,000

Question 9

An investment has the following characteristics:

ATIRRP: After-tax IRR on total investment in the property: 9.0%

BTIRRE: Before-tax IRR on equity invested: 17%

BTIRRP: Before-tax IRR on total investment in the property: 12%

t: Marginal tax rate: 0.40

What would be the break-even interest rate (BEIR) at which the use of leverage is neither favorable nor unfavorable?

Answer 9

15%

Question 10

All other things being equal, which of the following best describes the effects of leverage on an investment’s risk-return characteristics (assuming the expected return is greater than the lending rate)?

Answer 10

Higher average return, higher risk

Question 11

A property is financed with a 75 percent loan at 11.5 percent over 25 years. The property produces an ATIRR on total investment of 7.34 percent based on a tax rate of 31 percent. What can be said about the leverage associated with the property?

Answer 11

Negative Leverage Exists

Question 12

A property produces an 8.92 percent ATIRR on the total investment considering a tax rate of 28 percent. What is the maximum interest rate that could be paid on debt without causing the leverage to be negative?

Answer 12

12.39%

Question 13

A loan in which the lender receives a percentage of the net operating income from the property is known as a(n)

Answer 13

Participation Loan

Question 14

A loan in which the lender has an option to purchase an equity interest in a property is known as a(n):

Answer 14

Convertible

Question 15

Which of the following is also referred to as a negative amortization loan?

Answer 15

Accrual Loan

Question 16

A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a property is $45,000, what annual amount of debt service would provide the required debt coverage ratio?

Answer 16

$37,500 or lower

Question 17

A property is financed with an 85 percent loan-to-value ratio at 10 percent interest over 25 years. What would be the estimated BTIRRE on equity given that the BTIRRp is 10.75 percent?

Answer 17

10.1%

Question 18

Which of the following gives the lender an option to purchase a full or partial interest in the property at the end of some specified period of time?

Answer 18

Convertible Loan

Question 19

Lenders for income-producing properties refer to loans that are short term and require little or no amortization as:

Answer 19

Bullet Loan

Question 20

The maximum interest rate that could be paid on a debt before the leverage becomes unfavorable is referred to as the:

Answer 20

Break-even Interest Rate