Bob has $1,000,000 of his own equity capital available to make a real estate investment. He finds a bargain, a property with a market value of $1,100,000 that he can buy for $1,000,000. By how much can he enhance the market value of his net wealth by leveraging his purchase of this bargain property using borrowed money from a bank to finance 50% of his investment?
A) None. Conceptual question: NPV(fin) = 0 from MV perspective unless subsidized int. rate.
B) $50,000.
C) $100,000.
D) $200,000.
E) By 50%.

Question

Quizplus · Accepted Answer

BBob's net wealth increases by the difference between the market value of the property and the cost of purchasing it. Since he buys the property for $1,000,000, which has a market value of $1,100,000, he immediately gains $100,000 in net wealth. The financing method (leveraging) does not change the market value of the property or his net wealth; it only affects the amount of his own capital used in the purchase. Therefore, leveraging does not enhance the market value of his net wealth beyond the initial gain from purchasing the property below market value. However, B is correct because leveraging allows him to use less of his own money (50% financed by the bank), effectively doubling the impact of his initial equity on his return, assuming the property's value does not change.

Bob Has $1,000,000 of His Own Equity Capital Available to Make