Question

1. Suppose you are planning to develop a new apartment building next to Iowa State. You anticipate that the project will take two years to develop at a total cost of $3,000,000. Once open, you expect the building to produce a Net Operating Income of $250,000 annually.

You’ve arranged a financing package that covers the construction period with a two-year interest only (IO) loan offered at loan-to-value ratio of 80% and an annual interest rate of 6%. Once the building opens, you will pay-off the balance of the IO loan with a 20-year amortizing fixed-rate mortgage (FRM) with payments annually at an annual interest rate of 5%.

Based on this information, answer the following:

1. What is the initial loan balance and annual debt service payment due on the interest-only construction loan? (3 pts)

2. Once development is complete, what is the debt service payment due on the 20-year FRM? (3 pts)

Answer 1

(a) Calculation of intital loan balance and annual debt service payment

Total cost of project = $3,000,000

Loan to value ratio = 80%

Interest rate= 6%

Initial loan balance = Total cost of project * Loan to value ratio

= $3,000,000 * 80%

= $2,400,000

Annual debt service payment = Initial loan balance * Interest rate

= $2,400,000 * 6%

= $144,000

(b) Calculation of debt service payment due on 20-year FRM

Debt service payment due of 20-year FRM = [Initial loan balance*r*(1+r)^n] / [(1+r)^n - 1]

= [2,400,000*0.05*(1+0.05)^20] / [(1+0.05)^20 - 1]

= 318,396 / 1.6533

= $192,582.21