Assume Jean-Claude purchased real estate for $500,000 using $50,000 of which is his own money and $450,000 of which he borrowed at an 8 percent interest rate. If the value increased by 10 percent in one year and he sold the property, what was Joe’s rate of return on his investment? If the value of the property had declined by 2 percent, what would have been the rate of return on his investment?

Question

What will be an ideal response?

Answer 1

The 10 percent appreciation implies an increase of $50,000 (10 percent × $500,000). The interest payment on the loan would be $36,000 (8 percent × $450,000). As such, he has an additional $14,000 ($50,000 ? $36,000) with an original investment of $50,000 making his rate of return 28 percent ($14,000 ÷ $50,000).The 2 percent decline in value implies a decrease of $10,000 (5 percent × $500,000). The interest payment on the loan would again be $36,000 (8 percent × $450,000). As such, he lost $46,000 (?$10,000 ? $36,000) with an original investment of $50,000 making his rate of return ?92 percent ($46,000 ÷ $50,000).