Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

The owner of a warehouse/distribution facility wishes to obtain a new first mortgage on the property. The property has been completely leased to a Fortune

The owner of a warehouse/distribution facility wishes to obtain a new first mortgage on the property. The property has been completely leased to a Fortune 500 company with a AAA credit rating. The lease runs through 2035. The lease is a triple-net lease, which means the tenant is responsible for all operating expenses, including insurance, taxes, and utilities. For all intents and purposes, the owner has a risk-free cash flow for the next 15 years, which which he can use to obtain a mortgage on the property.

His banker has obtained loan proposals from four different lenders. Options 1-3 require payment of interest only up until the final payment. Option 2 has a reduced interest rate in years 1 and 2. Option 3 has a 2% fee added to the loan balance, in exchange for a reduced interest rate. Option 4 payments are lower than interest-only payments would be, with the difference accruing to the loan balance each year. For all four loan options, assume only one payment is made per year, at the end of the period. Here are the cash flows that the owner would have under each option (all figures in $000's):

Option

Option 1

  • Loan terms:Interest Only
  • Year 1: $50,000
  • Year 2: ($2,500)
  • Year 3: ($2,500)
  • Year 4: ($2,500)
  • Year 5-9: ($2,500)
  • Year 10: ($52,500)

Option 2

  • Loan term: Teaser Rate
  • Year 0: $50,000
  • Year 1: ($2,000)
  • Year 2: ($2,000)
  • Year 3: ($2,800)
  • Year 4: ($2,800)
  • Year 5-9: ($2,800)
  • Year 10: ($52,800)

Option 3

  • Loan Term: 2% fee
  • Year 0: $50,000
  • Year 1: ($2,423)
  • Year 2: ($2,423)
  • Year 3: ($2,423)
  • Year 4: ($2,423)
  • Year 5-0: ($2,423)
  • Year 10: ($53,424)

Option 4

  • Loan Term: Accruing
  • Year 0: $50,000
  • Year 1: ($2,000)
  • Year 2: ($2,000)
  • Year 3: ($2,000)
  • Year 4: ($2,000)
  • Year 5-9: ($2,000)
  • Year 10: ($61,657)

If the owner has a discount rate (i.e., personal cost of capital) of 8%, which is the best loan option?

Comparing Options 1 and 2, how many years until the cumulative undiscounted cash flows are the same?

How high would the owner's discount rate need to be for Option 3 to be better than Option 1?

At what discount rate does Option 4 have an NPV of zero?

If the owner takes Option 2, he will have an extra $200,000 at the end of Year 1. If he can invest that amount at 3%, what will it have grown to by the end of year 10?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Practical Financial Management

Authors: William R. Lasher

8th edition

1305637542, 978-1305887237, 1305887239, 978-1305637542

More Books

Students also viewed these Finance questions

Question

What does the term homoscedasticity mean?

Answered: 1 week ago