fundamentals of corporate finance 11th canadian edition test bank.docx
Finance tutorial v5
1. Real Estate Finance
Tutorial 1
Team Members:
NgewXinJie A0074471E
Lau Yung Yen A0074577R
Li Zhe A0078701E
Liu Mengyi A0070119N
Gao Han A0073228H
Chen Tianyi A0073854X
2. Question 2
2i) An investor obtained a fully amortizing mortgage 5 years
ago for $95,000 at 11 percent for 30 years. Mortgage rates
have dropped, so that a fully amortizing 25-year loan can
be obtained at 10 percent. There is no prepayment penalty
on the mortgage balance of the original loan, but three
points will be charged on the new loan and other closing
costs will be $2,000. All payments are monthly.
a) Should the borrower refinance if he plans to own the
property for the remaining loan term? Assume that the
investor borrows only an amount equal to the outstanding
balance of the loan.
4. 2(i)a Effective costs of
Refinancing
Contractual loan New loan Debt service
amount $92306.413
n=25x12
Total cost of taking a
new loan i=10%/12
$92306.413 X3% PV=-$92306.413
+$2000=$4769.192
Fv=0
Net loan amount
Cal pmt = $838.789
$875737.221
5. 2(i)a Effective costs of
Refinancing
n= 25x12
pmt = $838.789
PV=-87537.221
FV=0
Cal i= 0.891%
Therefore, Effective Costs of refinancing is
0.891%x12= 10.7%
Therefore, Since 10.7% < 11%, The borrower should
refinance
6. 2b
b) Would your answer to part (a) change if he plans to
own the property for only five more years?
Why?
7. 2b
No. Even he only plans to own the property for
five more years, he has to continue to pay the
loan.
8. 2c
Assuming that the investor plans to own the
property for the remaining loan term. What is the
minimum rate of return the investor expects if he
had used the amount meant to pay for the
refinancing costs to make an alternative
investment?
9. 2c Yield For Refinancing
Opportunity
Monthly debt service for existing loan
$904.707
New loan Debt service
pmt=$838.789
Monthly savings for 25 years
$904.707-$838.789=$65.918
11. 2d
Assuming an alternative investment gives a return
of 18%. Should the investor refinancing his original
loan?
12. 2d
No. Since 18%>16.3%, he should use this amount
to $4769.192 to make an alternative investment.
13. 2(ii)
What are the primary considerations that should
be made when refinancing?
Save money
The loan terms on your existing loan
The loan terms on your new loan
The cost of switching
14. 2(iii)
What factors must be considered when deciding
whether to refinance a loan after interest rates
have declined?
15. 2(iii)
The cost of refinance
Prepayment penalty on the existing loan
Original fee and incidental closing cost on the new
loan
The yield for the particular “refinance”
opportunity
The yield for the alternative investment
Effective cost of refinancing
Editor's Notes
Primary Considerations When RefinancingSave moneyTerms of existing loan and new loanLower interest rateLower monthly paymentCost of refinancing
Lower interest rate will decrease the amount of monthly debt service but not necessary means that you will benefit from the monthly saving as there will be additional cost imposed to refinance. The cost of refinance will affect on the yield for the particular refinance opportunity. The mortgagor should refinance if the yield for the particular refinance opportunity is higher than the yield for the alternative investment. Another factor is the effective cost of refinancing. The morgagor should not refinance if the effective cost of refinancing is higher than the interest rate on the existing loan.