Chapter 11: Financial Leverage. Leverage = Adding Debt Leverage and ATIRR Condition for Positive Leverage: Un-levered ATIRR > (1 – tax rate) * Cost of Debt Leverage will raise returns if the project earns more than the after-tax cost of debt.
Leverage = Adding Debt
Leverage and ATIRR
Un-levered ATIRR > (1 – tax rate) * Cost of Debt
Breakeven Interest Rate:
Rate = Un-levered ATIRR/(1 – tax rate)
Leverage is wide-spread in Real Estate
Leverage raises risk. The risk is possibility that the project will default on the debt and result in foreclosure.
Investors may choose to default if the value of the property is though to be less than the value of the debt.
Examples of common financial arrangements:
Problems: 11-1, 11-2 (page 390)