REE 4204 Exam 3 UPDATED
QUESTIONS AND CORRECT ANSWERS
The value of an income-producing asset - CORRECT ANSWER is a function of the income
accruing to the asset.
Income is generally measured as - CORRECT ANSWER some form of cash flow.
Cash flows and discount rates can sometimes be hard to determine due - CORRECT ANSWER
to the nature of the asset.
Investor has two basic sources of financing: - CORRECT ANSWER debt and equity.
Financial leverage - CORRECT ANSWER is the use of debt in financing
Positive leverage - CORRECT ANSWER the use of debt at a cost less than the return on the
asset; increases the return on equity.
Negative leverage - CORRECT ANSWER the use of debt at a cost greater than the return on
the asset; reduces the return on equity.
Neutral leverage - CORRECT ANSWER the debt cost is equal to asset return and return on
equity is not affected.
The risk to the equity is increased by - CORRECT ANSWER the use of financial leverage.
Leverage allows the cash flows to be divided into two components - CORRECT ANSWER less
risky and more risky.
Value can be created if - CORRECT ANSWER debt holders and equity holders have different
risk-return preferences
,More risk-averse investor can invest in - CORRECT ANSWER the lower-risk debt and less
risk-averse investor can invest in riskier equity.
Tax-deductibility of interest payments on debt make it - CORRECT ANSWER advantageous
Federal government subsidizes the use of debt by - CORRECT ANSWER §providing tax
relief.
Real Estate Cash Flow Structure - NOI - CORRECT ANSWER Gross Rent (GR)
- Vacancy (VAC)
+ Other Income (OI)
= Effective Gross Income (EGI)
- Operating Expenses (OE)
= Net Operating Income (NOI)
Real Estate Cash Flow Structure - ATCF - CORRECT ANSWER Net Operating Income (NOI)
- Mortgage Payment (MP)
= Before-Tax Cash Flow (BTCF)
- Tax Liability (Savings) (TXS)
= After-Tax Cash Flow (ATCF)
Taxes from Operations - CORRECT ANSWER Net Operating Income (NOI)
- Interest Expense (INT)
- Depreciation (DEP)
= Taxable Income (TI)
x Investor's Marginal Tax Rate (t)
= Taxes (Savings) from operations (TXS)
After-Tax Equity Reversion - CORRECT ANSWER Estimated Selling Price (ESP)
- Selling Expenses (SE)
= Net Sales Price (NSP)
, - Unpaid Mortgage Balance (UMB)
= Before-Tax Equity Reversion (BTER)
- Total Taxes on Resale (TXR)
= After-Tax Equity Reversion (ATER)
Taxable Income from Resale - CORRECT ANSWER Estimated Selling Price (ESP)
- Selling Expenses (SE)
= Amount Realized on Sale (AR)
- Adjusted Basis (AB)
= Total Gain from Sale (TG)
- Depreciation Recovery (DR)
= Capital Gain from Resale (CG)
Taxes Due on Resale - CORRECT ANSWER Depreciation Recovery (DR)
x Depreciation Recovery Tax Rate (td)
= Depreciation Recovery Tax (DRT)
Capital Gain
x Capital Gains Tax Rate (tg)
= Capital Gains Tax (CGT)
Depreciation Recovery Tax (DRT)
+ Capital Gains Tax (CGT)
= Total Tax on Resale (TXR)
NPV - CORRECT ANSWER -The present value of the cash flows minus the present value of
the cash outflows.
-Appropriate discount rate is the risk-adjusted required rate of return.
-In the previous example the after-tax cash flows are equity cash flows thus the appropriate discount
rate is the required equity yield.
QUESTIONS AND CORRECT ANSWERS
The value of an income-producing asset - CORRECT ANSWER is a function of the income
accruing to the asset.
Income is generally measured as - CORRECT ANSWER some form of cash flow.
Cash flows and discount rates can sometimes be hard to determine due - CORRECT ANSWER
to the nature of the asset.
Investor has two basic sources of financing: - CORRECT ANSWER debt and equity.
Financial leverage - CORRECT ANSWER is the use of debt in financing
Positive leverage - CORRECT ANSWER the use of debt at a cost less than the return on the
asset; increases the return on equity.
Negative leverage - CORRECT ANSWER the use of debt at a cost greater than the return on
the asset; reduces the return on equity.
Neutral leverage - CORRECT ANSWER the debt cost is equal to asset return and return on
equity is not affected.
The risk to the equity is increased by - CORRECT ANSWER the use of financial leverage.
Leverage allows the cash flows to be divided into two components - CORRECT ANSWER less
risky and more risky.
Value can be created if - CORRECT ANSWER debt holders and equity holders have different
risk-return preferences
,More risk-averse investor can invest in - CORRECT ANSWER the lower-risk debt and less
risk-averse investor can invest in riskier equity.
Tax-deductibility of interest payments on debt make it - CORRECT ANSWER advantageous
Federal government subsidizes the use of debt by - CORRECT ANSWER §providing tax
relief.
Real Estate Cash Flow Structure - NOI - CORRECT ANSWER Gross Rent (GR)
- Vacancy (VAC)
+ Other Income (OI)
= Effective Gross Income (EGI)
- Operating Expenses (OE)
= Net Operating Income (NOI)
Real Estate Cash Flow Structure - ATCF - CORRECT ANSWER Net Operating Income (NOI)
- Mortgage Payment (MP)
= Before-Tax Cash Flow (BTCF)
- Tax Liability (Savings) (TXS)
= After-Tax Cash Flow (ATCF)
Taxes from Operations - CORRECT ANSWER Net Operating Income (NOI)
- Interest Expense (INT)
- Depreciation (DEP)
= Taxable Income (TI)
x Investor's Marginal Tax Rate (t)
= Taxes (Savings) from operations (TXS)
After-Tax Equity Reversion - CORRECT ANSWER Estimated Selling Price (ESP)
- Selling Expenses (SE)
= Net Sales Price (NSP)
, - Unpaid Mortgage Balance (UMB)
= Before-Tax Equity Reversion (BTER)
- Total Taxes on Resale (TXR)
= After-Tax Equity Reversion (ATER)
Taxable Income from Resale - CORRECT ANSWER Estimated Selling Price (ESP)
- Selling Expenses (SE)
= Amount Realized on Sale (AR)
- Adjusted Basis (AB)
= Total Gain from Sale (TG)
- Depreciation Recovery (DR)
= Capital Gain from Resale (CG)
Taxes Due on Resale - CORRECT ANSWER Depreciation Recovery (DR)
x Depreciation Recovery Tax Rate (td)
= Depreciation Recovery Tax (DRT)
Capital Gain
x Capital Gains Tax Rate (tg)
= Capital Gains Tax (CGT)
Depreciation Recovery Tax (DRT)
+ Capital Gains Tax (CGT)
= Total Tax on Resale (TXR)
NPV - CORRECT ANSWER -The present value of the cash flows minus the present value of
the cash outflows.
-Appropriate discount rate is the risk-adjusted required rate of return.
-In the previous example the after-tax cash flows are equity cash flows thus the appropriate discount
rate is the required equity yield.
