Suppose you expect that one year from now, a certain property's before-tax cash flow (PBTCF = NOI - CI) will equal only $15,000 per year under a plausible pessimistic scenario or as much as $25,000 per year under a plausible optimistic scenario. If you borrow an amount such that the loan payments will be $10,000 per year (for certain), then what is your range of expected income return component (equity yield) under the no-leverage and leverage alternatives, assuming that the property price is $200,000 and the loan amount is $100,000?
A) It goes from a range of between 7.5% and 12.5% with no leverage to a range of between 2.5% and 7.5% with leverage.
B) It goes from a range of between 15% and 25% with no leverage to a range of between 5% and 15% with leverage.
C) It goes from a range of between 2.5% and 7.5% with no leverage to a range of between 15% and 25% with leverage.
D) It goes from a range of between 7.5% and 12.5% with no leverage to a range of between 5% and 15% with leverage.
E) Can't be determined from the information given.

Question

Quizplus · Accepted Answer

The income return component (equity yield) without leverage is calculated by dividing the PBTCF by the total property price. With leverage, it's calculated by subtracting loan payments from the PBTCF and then dividing by the equity portion of the investment. Without leverage, the range is $15,000/$200,000 to $25,000/$200,000, which is 7.5% to 12.5%. With leverage, the range is ($15,000-$10,000)/$100,000 to ($25,000-$10,000)/$100,000, which is 5% to 15%.

Suppose You Expect That One Year from Now, a Certain