Deck 14: Disposition and Renovation of Income Properties

Question 1

A property,if sold today,will provide the equity investor with $150,000 in cash flow after taxes.If the property is held,the annual after-tax cash flow received by the investor will be as follows: $18,000 for years 1 to 5,$24,000 for years 6 to 10.If held and sold in 10 years,the property is expected to provide $180,000 in after-tax cash flow to the investor.What should the investor do if she can receive a 14% rate of return by investing the sales proceeds today in an different project?

A) Sell the property and invest proceeds in the second property
B) Do not sell the property
C) Renovate the property
D) Can't tell without knowing the cash flow from the second property

Answer 1

Do not sell the property

Question 2

Which of the following factors would NOT be considered when an investor is trying to decide whether to hold or sell a property at the end of year five?

A) After-tax operating income in year five
B) After-tax cash flow from the sale in year five
C) After-tax cash flow from sale in the future
D) After-tax operating income after year five

Answer 2

After-tax operating income in year five

Question 3

An investor is considering refinancing a property.The current mortgage has an interest rate of 8.75% and a mortgage balance equal to 45% of the property value due to amortization of the loan and some appreciation in value.However,the investor would like to refinance at an amount equal to 75% of the property value.He has found out that the property can be refinanced at a 75% loan-to-value ratio for 9.5% interest over 15 years.What can be said about the incremental cost of refinancing?

A) It will be higher than 9.5%
B) It will be less than 9.5%
C) It will be equal to 9.5%
D) Can't tell without additional information

Answer 3

It will be higher than 9.5%

Question 4

Which of the following represents the formula for the annual marginal rate of return (MRR)when trying to decide whether to hold or sell a property? ATCF_S equals the after-tax cash flow from sale and ATCF_O equals the after-tax cash flow from operations.

A) MRR = (ATCF_S (year t + 1)+ ATCF_O (year t + 1)- ATCFS (year t)- ATCF_O (year t)/ ATCF_S (year t)
B) MRR = (ATCF_S (year t + 1)- ATCF_O (year t + 1)+ ATCF_S (year t))/ ATCF_S (year t)
C) MRR = (ATCF_S (year t + 1)+ ATCF_O (year t + 1)- ATCF_S (year t))/ ATCF_S (year t)
D) MRR = (ATCF_S (year t + 1)+ ATCF_O (year t + 1)+ ATCF_S (year t))/ ATCF_S (year t)

Question 5

The marginal rate of return can be defined as:

A) thereturn that results from holding the property for one additional year.
B) theIRR the year the internal rate of return starts to decrease from holding the property.
C) theincremental return over a holding period resulting from renovating a property.
D) therate of return at which the net present value equals zero.

Question 6

Given the same expectations for future rents and expenses,a new buyer may earn a different after-tax return than the current owner of the same property.

Question 7

An investor purchased a building in 1982 when the building could be depreciated over 19 years.A new investor is interested in purchasing the building in 1992 when the depreciable life according to tax laws is 31.5 years.Assuming both investors are in the same tax bracket and that everything else is equal,what can be said about the after-tax cash flow received by the new investor as compared to the after-tax cash flow that would be received by the original owner of the building?

A) The new investor will have a higher after-tax cash flow because the depreciation expense will be lower
B) The new investor will have a higher after-tax cash flow because the depreciation expense will be higher
C) Both investors will have to use the 31.5 year depreciable life after 1986 so the after-tax cash flow will be equal
D) The new investor will have a lower after-tax cash flow because the depreciation expense will be lower

Question 8

A property should be sold when which of the following occurs?

A) The marginal rate of return is rising but less than the reinvestment rate
B) The marginal rate of return is constant
C) The marginal rate of return is zero
D) The marginal rate of return is falling and becomes equal to the reinvestment rate

Question 9

Which of the following is NOT a benefit to Refinancing?

A) Allows investor to increase financial leverage.
B) It is an alternative to sale of the property.
C) Risk is decreased
D) No taxes have to be paid on funds received by additional borrowing.

Question 10

An investor is considering renovating a building.Total cost of renovations are expected to be $100,000 of which 75% can be borrowed.Given the after-tax cash flows to the equity investor as showed below,what is the incremental return from renovating?

A) 9.75%
B) 10.14%
C) 15.32%
D) 12.67%

Question 11

Disposition when dealing with real estate means which of the following?

A) The way a property fits in with its surroundings
B) Refinancing the property
C) Improving property value
D) Sale of the property

Question 12

An investor purchased a property expecting to receive a 14% rate of return.However,the rate of return on the property over a 5 year holding period turned out to be only 11.5%.Therefore,the property should be sold.

Question 13

A property worth $16 million can be refinanced with an 80% loan at 9.5% over 20 years.The balance on the current loan is $12,148,566.Loan payments are $113,302 per month.The loan balance in 10 years will be $8,396,769.If the property is expected to be sold in 10 years,what is the incremental cost of refinancing?

A) 9.71%
B) 10.36%
C) 12.42%
D) 14.58%

Question 14

The benefits of equity buildup in a property are lessened over time because with an amortizing mortgage,an investor will lose some tax benefits each year as the interest portion of the payments decreases.

Question 15

An investor calculates an incremental return of renovating a building of 14%.Other properties provide a 12.5% overall rate of return to equity investors.Therefore,the property is a good investment.

Question 16

The return calculated assuming the property is held for one additional year is referred to as the

A) After tax cash flow from sale
B) Marginal rate of return
C) Reinvestment rate
D) None of the above

Question 17

After the 1986 tax law change,investors that already owned properties had to change the way they were depreciating the properties.

Question 18

Which of the following cash flows would be considered when an investor is trying to decide whether to renovate a property?

A) After-tax operating income before renovation
B) The difference between future operating income if renovated and if not renovated
C) After-tax cash flow from sale the year of renovation
D) The mortgage balance on the property the year before renovation

Question 19

A property could be sold today to provide an after-tax cash flow from sale of $800,000.The current after-tax cash flow from operations is $20,000,which is expected to grow by 4% per year.If sold next year,the property is expected to provide an after-tax cash flow of $824,000.What is the marginal rate of return for holding the property for an additional year?

A) 5.6%
B) 2.6%
C) 3.1%
D) 9.3%

Question 20

In general,equity buildup tends to lower the marginal rate of return of holding a property.

Question 21

For refinancing to be profitable,the effective cost of the debt must be less than the unlevered return on the projects being financed.

Question 22

Equity buildup should always be avoided if possible.

Question 23

The marginal rate of return on a property usually increases until sale of the property.

Question 24

A property should be sold when the marginal rate of return falls below the rate at which funds can be reinvested.