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Lecture 11 Financial Leverage - Feb 24 09

Lecture 11 Financial Leverage - Feb 24 09 - Financial...

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1 Financial Leverage and Financing Alternatives
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2 Why Should an Investor Use Debt?
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3 Why Should and Investor Use Debt? 1. May not have enough equity (cash) to buy the property. 2. Take advantage of Tax deductibility of mortgage interest. 3. Realize the benefits of financial leverage What are the benefits of financial leverage?
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4 Financial leverage benefits occur when the rate of interest on borrowing is less than the rate of return on the investment. Unleveraged Cost of IRR Loan Unleveraged Cost of IRR Loan Unleveraged Cost of IRR Loan Good Bad Breakeven
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5 Commercial Building
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6 *
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7 Commercial Building Example Assuming 80% Loan End of Year 0 1 2 3 4 5 BTCF $-20,000 $4,000 $4,000 $4,000 $4,000 24,000 ATCF -20,000 3,636 3,636 3,636 3,636 19,858 Before- tax IRR (BTIRR) = 20.000% After-tax IRR (ATIRR) =15.40%
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8 Commercial Building Example No loan Cash Flow Summary End of Year 0 1 2 3 4 5 Before-tax cash flow $-100,000 $12,000 $12,000 $12,000 $12,000 $112,000 After-tax cash flow -100,000 9,396 9,396 9,396 9,396 105,618 Before-tax IRR (BTIRR) =12.00% After-tax IRR (ATIRR) =8.76%
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Lecture 11 Financial Leverage - Feb 24 09 - Financial...

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