The use of financial leverage in purchasing an income-producing property can affect the amount of cash required at acquisition, the net cash flows from rental operations, the net cash flows from the eventual sale of the property, and the ultimate return on invested equity. Assuming the going-in IRR is greater than the effective borrowing cost, if an investor increases his leverage rate, say from 75% to 80%, we would expect which of the following to occur?
A) Both NPV and going-in IRR increase
B) NPV decreases, while going-in IRR increases
C) NPV increases, while going-in IRR decreases
D) Both NPV and going-in IRR decrease

Question

Quizplus · Accepted Answer

When the going-in IRR is greater than the effective borrowing cost, increasing leverage typically increases both the NPV and the going-in IRR, as the cost of borrowing is less than the return on the investment, enhancing returns on equity.

The Use of Financial Leverage in Purchasing an Income-Producing Property