Question

[Related to Solved Problem 11.1] Suppose that you intend to buy a house for $190,000. Calculate your leverage ratio for this investment in each of the following situations: You pay the entire $190,000 price in cash. Leverage ratio is equal to : You make a 20% down payment. Leverage ratio is equal to You make a 10% down payment. Leverage ratio is equal to You make a 5% down payment. Leverage ratio is equal to Now assume that at the end of the year, the price of the house has risen to $209,000. Calculate the return on your investment for each of the situations listed above. In your calculations, ignore interest you pay on the mortgage loan and the value of any housing services you receive from owning your home. a. You pay the entire $190,000 price in cash. Return on investment is equal to % b. You make a 20% down payment Return on investment is equal to 1%

Answer 1

1.

a. Leverage ratio = Nil.

b. Leverage ratio = Debt / Equity

=> 190,000*80% / 190,000*20% => 4

c. Leverage ratio = Debt / Equity

=> 190,000*90% / 190,000*10% => 9

d. Leverage ratio = Debt / Equity

=> 190,000*95% / 190,000*5% => 19

2.

a. Return on Investment = (209,000 - 190,000)/ 190,000 => 10%

b. Return on Investment = (209,000 - 190,000)/ 190,000 * 20% => 50%

c. Return on Investment = (209,000 - 190,000)/ 190,000 * 10% => 100%

d. Return on Investment = (209,000 - 190,000)/ 190,000 * 5% => 200%

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