1. Compare the following mortgages and determine which has the lower cost:
|
|
FRM
|
ARM
|
|
Mortgage amount
|
$100,000
|
$100,000
|
|
Term
|
30 years
|
30 years
|
|
Discount points
|
2.00
|
3.25
|
|
Initial contract interest rate
|
9.75%
|
7.75%
|
|
Margin
|
...
|
2.75
|
|
Caps
|
...
|
2% annual, 6% lifetime
|
|
Index value at outset
|
...
|
7.75%
|
|
Prepayment
|
End of year 3
|
End of year 3
|
Assume that the ARM rate adjusts from the initial beginning rate and the index has the following values:
|
BEGINNING OF THE YEAR
|
INDEX VALUE
|
|
1
|
7.75%
|
|
2
|
9.00
|
|
3
|
10.75
|
2. Consider a property with expected future net cash flows of $25,000 per year for the next five years (starting one year from now). After that, the operating cash flow should step up 20%, to $30,000, for the following five years.
a. If you expect to sell the property 10 years from now for a price 10 times the net cash flow at that time, what is the value of the property if the required return is 12%?
b. Suppose the seller of the building wants $260,000. Should you do the deal? Why or why not? What is the IRR if you pay $260,000? How does this compare to the required return of 12%?
What is the IRR if you could get the seller to accept $248,075 for the property? What is the
NPV at that price?
c. Suppose that the required return on the property is 11% instead of 12% (in comparison to part b). What would the value of the property be? By what percentage has this value changed as a result of this 100-basis-point change in the required return?