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2 questions · 1 formulas

Interest-only payment

Payment = L × i

Mortgage & LeverageE-levelHigh priority

A $70,000,000 interest-only loan carries a 5.5% annual interest rate, with no amortization during the hold. What is the annual interest payment, and what happens to the principal at maturity?

→ A) $3,850,000 annual interest; full $70,000,000 principal repaid as a balloon payment at maturity

Computer Lab 5 — Exercise 2, Step 2

  • A) $3,850,000 annual interest; full $70,000,000 principal repaid as a balloon payment at maturity
  • B) $3,850,000 annual interest; principal amortizes gradually like a standard CPM loan
  • C) $7,000,000 annual interest; no principal repayment needed
  • D) $385,000 annual interest; balloon payment at maturity

Annual interest = 70,000,000 × 5.5% = 3,850,000. Since the loan is interest-only, no amortization occurs; the entire $70,000,000 principal is repaid as a balloon payment at maturity.

Rule: Interest-only loans: fixed interest each year during the hold, full principal repaid at maturity (no CPM amortization).

DCF / NPV / IRRD–A levelVery high priority

With a $100,000,000 purchase financed by a $70,000,000 interest-only loan at 5.5%, lender participation of $4,333,058 in appreciation at sale, and a Year 5 sale price of $121,665,290.24 plus NOI of $7,878,561.67, the levered IRR is 19.52% versus an unlevered IRR of 10.88%. What does this indicate?

→ A) Positive financial leverage, since the levered IRR exceeds the unlevered IRR

Computer Lab 5 — Exercise 2, Task 1

  • A) Positive financial leverage, since the levered IRR exceeds the unlevered IRR
  • B) Negative financial leverage, since borrowing reduced the return
  • C) The loan had no effect on investor returns
  • D) The participation feature eliminated all leverage benefit

Because 19.52% (levered) > 10.88% (unlevered), using debt increased the equity investor's return — this is positive financial leverage, meaning the asset's unlevered return exceeds the cost of debt.

Rule: Positive leverage occurs when the levered IRR to equity exceeds the unlevered IRR; this happens when borrowing cost is below the asset's return.