You are a commercial real estate broker eager to sell an office building. An investor is interested but demands a 20 percent return on her equity investment. The building’s selling price is $25 million, and it promises free cash flows of $3 million annually in perpetuity. Interest-only financing is available at 8 percent interest; that is, the debt is outstanding forever and requires no principal payments. The tax rate is 50 percent.
a. Propose an investment-financing package that meets the investor’s return target.
b. Propose an investment-financing package that meets the investor’s target when she demands a 90 percent return on equity.
c. Why would an investor settle for a 20 percent return on this investment when she can get as high as 90 percent?
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