Question

One year ago you bought a $1,000,000 house partly funded using a mortgage loan. The loan size was $800,000 and the other $200,000 was your wealth or 'equity' in the house asset. The interest rate on the home loan was 4% pa. Over the year, the house produced a net rental yield of 2% pa and a capital gain of 2.5% pa. Assume that all cash flows (interest payments and net rental payments) were paid and received at the end of the year, and all rates are given as effective annual rates including the home loan rates. What was the total return on your wealth over the past year?

Select one: a. 0.4808% pa b. 2% pa c. 4.5% pa d. 6.5% pa e. 8.5% pa

Answer 1

Property value = $1,000,000

Mortgage Loan = $800,000

Owner's equity (down payment) = $200,000

Mortgage loan interest rate = 4%

Net rental yield = 2%

Capital gain = 2.5%

Property value appreciation = Capital gain * Property value

Property value appreciation = 2.5% * $1,000,000

Property value appreciation = 25,000

Net Rental Amount = Net rental yield * Property value

Net Rental Amount = 2% * $1,000,000

Net Rental Amount = $20,000

Mortgage Interest Payment = Mortgage loan interest rate * Mortgage Loan

Mortgage Interest Payment = 4% * $800,000

Mortgage Interest Payment = $32,000

Total return on investment = (Property value appreciation + Net Rental Amount - Mortgage Interest Payment ) / Owner's equity

Total return on investment = ($25,000 + $20,000 - $32,000) / $200,000

Total return on investment = $13,000 / $200,000

Total return on investment = 6.5%