Question

Impact of Leverage on investment Mary uses $500,000 of her cash to purchase 40 acres of land with a total cost of $500,000. Mary is not using financial leverage. Sue uses $500,000 of her cash and borrows $1,000,000 to purchase 120 acres of land having a total cost of $1,500,000 Sue is using financial leverage to own/control $1,500,000 of property with only $500,000 of her own money. Let's also assume that the interest on Sue's loan is $50,000 per year and it is paid at the beginning of each years, What is the return on equity(investment) for Mary and Sue if the land was appreciated by 20% next year? What if the land was depreciated by 20%?

Answer 1

No leverage:
Mary return when Land appreciates by 20% = 20%
Mary return when Land depreciates by 20% = -20%

Leverage:
Sue return when Land appreciates by 20% = 50%
Sue return when Land depreciates by 20% = -70%

Mary & Return land Appreciated by 20% 500,000 X207 500, ovo = 20.7. land depreciates by 20%. 500,000 x-2014 500, oro = -20% Sue land appreciates by 20%. 1,500,000 * 20% - 50,000 (interesteost) - = 50% 50D, ou land deprecates by 20%. 1,500,000 x -20% -50,000 - 70% 50,0