Mr. Toh is considering the purchase of a house along Farrer Road for investment. The property is expected to have a NOI of $185,000 in the first year. The NOI is expected to increase by 2.5% per year thereafter. The house is currently valued at $5,000,000. Mr. Toh expects to sell the house at the end of 3 years for $6,000,000, realizing a gross profit of $1,000,000. Mr. Toh is considering two monthly-amortizing loans. The first loan is a 70% financing loan at an interest rate of 2.5% per annum for 25 years and the second loan offers 60% financing at 4% per annum for 25 years. Assume a selling expense (that includes sellerâ€™s stamp duty) of 9% of the sale price and a tax rate of 18%.
(a) What would the before-tax IRR (BTIRR) on equity and the after-tax (ATIRR) on equity be at each level of financing?
(b) Does each loan offer favourable financial leverage? Which loan would you recommend to Mr. Toh?