Just did a EOC question 8 form Private Real Estate chapter, it states using a mortgage on property #1 would most likely result in earning: a higher return on euqity.
The answer says: the quoted mortgage interest rate is: 5.75% which is less than the discount rate of 7.25%.
How does the lower rate connect with the higher RETURN on EUQITY?
Thank you!
The less interest you pay, the more money you keep in your pocket.
If my funding cost of a proyect is lower than the required rate of return (discount rate) on it, then I will gain the spread between
re - rd x (1-t)
re = required return on equity (discount rate)
rd = cost of debt before tax
This is one of the reasons why people take debt. Another is lack of money.
Just want to confirm.
the lower the interest -> higher Net Income ->higher return on equity while we assume the equity stays the same, is this correct?
Thank you!
Yup.
Exactly.
Thank you both of you!
You’re welcome.