CFAT/ ERAT Debt Service balance, selling, interest, mortgage, understand

dreampak

For calculating CFAT and ERAT, do you think they will give us the annual debt service cost/ interest expense and the outstanding mortgage balance? I was looking over Schweser Volume 1 Exam 1 Afternoon Questions 91- 96.

In #94, they ask you for the ERAT, and hence you need to mortgage balance. I understand that the total mortgage will total $32M (80% of selling price), but after 5 years, shouldn't the balance be less than $32M? They simply used the $32M in the answer. I spent so much time trying to figure out the remaining balance on my calculator..

In #95 when they have for the CFAT, is the debt service cost always just the interest cost on the loan? And why is this the same amount each year? (interest cost x mortgage total)... doesn't your interest cost decline each year as you pay off the principal? I was trying to use my calculator to come up with the monthly mortgage payment and then multiply by 12 to get annual... but apparently they just really simplified things...

tarunajwani

1.
#94
my guess is that it sticks to the following assumption (also mentioned in Schweser notes 'Investment Analysis')
- either the amortization schedule is provided
- either it's interest-only loan

I think it uses 'interest-only' (which actually conflicts with the fact that it's 30-year loan)
- the mortgage balance won't reduce much in the first 5 year though, so this approximation is still tolerable, I guess

2.
#95
'interest-only' => debt service equal to interest expense (no principal reduction!)

3.
a better example is the one in the CFA book
==================================
Debt contribution: a fixed-rate mortgage is obtained for $393,750 at 8 percent per annum (compounded monthly) for 30 years. The monthly payment to amortize this loan is $2,889.20
(Level II Volume 5 Alternative Asset Valuation and Fixed Income , 5th Edition. Pearson Learning Solutions p. 18).

interest expense
??31,381
??31,108
??30,812
??30,492

annual debt service = 34,670 (= 2889.20 *12)
(I/Y, N, PV, FV=0 -> PMT = $2,889.20 )

mortgage balance initial = 393,750
mortgage balance outstanding = 378,862

the difference between the annual debt service and annual interest expense is not so big relative to the amount of loan
total difference (principal reduction) = reduction in mortgage balance = about 15,000