Calculating Maximum value of loan (Alternatives)

CFA Level II
#1

A building is appraised and purchased at £6m will create a £500,000 NOI in Y1. The bank lends at 10% interst only and has specified a maximumum LTV of 75% and DSCR of 1.25

What is the maximum loan?

I am trying to follow a solution but getting stuck.

The LTV = 75% x 6m = 4.5m

I thiought this would be final answer, but now we have to incorporate the DSCR?

DSCR = NOI/debt service … rearrange we hget 500K/1.25 = 400k (max debt service). However, the final answer suggests the correct answer is maximum loan is 4m taking into account 10% interest. Can someone clarify this please?

#2

Apparently, they’re assuming that it’s an interest-only loan.

That’s silly.

Nevertheless, if it’s an interest-only loan, then the maximum debt service of £400,000 corresponds to a maximum loan amount of:

£400,000 / 10% = £4,000,000

That’s less than the maximum loan value based on the LTV, so that’s that.

(Note: if the question writer had done his job properly, he’d have made the loan amortizing: you’d have had to have calculated the present value of an amortizing loan with a £400,000 payment (PMT) and used that.)

#3

Thank you Bill! Top man.

Rex.

#4

My pleasure.

#5

in the question - they said --> The bank lends at 10% interst only -> hence their answer seems reasonable, I think.

#6

I agree that the answer’s correct.

I simply think that it would be more realistic for the question to have been based on an amortizing loan; interest-only loans aren’t particularly common for mortgages.

#7

Ironically enough this question is a variation of the CFA Curriculum question which also uses interest only. Anyway thanks all for the help.

#8

I’m aware that the CFA Institute questions use interest only. Their authors were lazy, too.

I wrote an example question like this one for the Level II lecture notes I created for Wiley; I used an amortizing loan. Level II candidates can handle that.