General information

You are interested in investing in a building costing $10,000,000.$

You can either finance the purchase of the building using either:

$>$ Mortgage A and a $40\%$ loan$-$to$-$value ratio; or

$>$ Mortgage $B$ and a $50\%$ loan$-$to$-$value ratio.

Further details regarding the mortgages are provided in Table $1.$

You require an $8\%$ return on an unlevered equity investment.

You anticipate receiving $1,000,000$ in rental income at the end of every year for five years.

You plan to sell the building after five years for $11,000,000.$

Table $1$: Mortgage details.

Question $1$

$1\mathrm{.}1$ Assuming that Mortgage $A$ is selected, calculate the levered cost of equity.

$1\mathrm{.}2$ Assuming that Mortgage B is selected, calculate the levered cost of equity.

$($Answer the questions in the corresponding area of the Answer sheet$)$

Question $2$

$2\mathrm{.}3$ Based on your answers in $2\mathrm{.}1$ and $2\mathrm{.}2,$ state which mortgage you would choose, and justify your answer. Limit your answer to $50$ words.

$($Answer the questions in the corresponding area of the Answer sheet$)$

Table $1$: Mortgage details.

Mortgage A Mortgage B

Interest rate per annum $5\%5\%$

Compounded Annually Annually

Payment frequency Annually in arrears Annually in arrears

Type Interest$-$only Constant payment

Loan$-$to$-$value ratio $40\%50\%$

Term $($years$)55$

Question $1$

$1\mathrm{.}1$ Assuming that Mortgage A is selected, calculate the levered cost of equity.

$1\mathrm{.}2$ Assuming that Mortgage B is selected, calculate the levered cost of equity.

$($Answer the questions in the corresponding area of the Answer sheet$)$

Question $2$

$2\mathrm{.}1$ Assuming that Mortgage A is selected, calculate the net present value of the investment. Use the cost of equity that you calculated in Question $1\mathrm{.}1$ as the appropriate discount rate. Round your calculated answer to the nearest pound.

$2\mathrm{.}2$ Assuming that Mortgage B is selected, calculate the net present value of the investment. Use the cost of equity that you calculated in Question $1\mathrm{.}2$ as the appropriate discount rate. Round your calculated answer to the nearest pound.

$2\mathrm{.}3$ Based on your answers in $2\mathrm{.}1$ and $2\mathrm{.}2,$ state which mortgage you would choose, and justify your answer. Limit your answer to $50$ words.

$2\mathrm{.}4$ Now, assume that the net present value of the investment is identical with either mortgage $($i$.$e$.$ ignore your answers to $2\mathrm{.}1$ and $2\mathrm{.}2).$ What would the advantage be of opting for Mortgage A$?$ Justify your answer. Limit your answer to $100$ words.