Question

You are considering the purchase of an industrial warehouse. The purchase price is $1 million. You expect to hold the property for five years. You have decided to finance the acquisition with the $700,000 loan, 10% interest rate, 30- year term, and annual interest-only payments. (That is, the annual payment will not include any amortization of principal.) There are no up-front financing costs. You estimate the following cash flows for the first year of operations:

Effective gross income $135,000
Operating expenses 27,000
NOI $108,000
A. Calculate the overall rate of return (or "cap rate").
B. Calculate the debt coverage ratio.
C. What is the largest loan that you can obtain (holding the other terms constant) if the lender requires a debt service coverage ratio of at least 1.2?

Answer 1

A. Cap rate = Debt Service/Current market price of asset

= $70,000/$1,000,000 * 100

= 7%

B. Debt coverage ratio = Net Operating Income/Debt Service

= $108,000/$70,000

= 1.54

C. The largest loan that can be obtained (other terms held constant) if the lender requires a debt service coverage ratio of at least 1.2 is:

= ($70,000 * 1.2)/10%

= $840,000

Step-by-step explanation:

a) Data and Calculations:

Purchase price of the industrial warehouse = $1 million

Loan to finance acquisition = $700,000

Interest rate = 10%

Term of loan = 30 years

Type of loan repayment = interest-only payments

Annual debt service = $70,000 ($700,000 * 10%)

Effective gross income $135,000

Operating expenses 27,000

Net Operating Income $108,000