Finance Case Studies
CASE A
Mr. Rahman is evaluating two nancing oers for a at in Mirpur DOHS worth 85,000,000.
Payments are monthly in both cases.
Oer 1 (Brac Bank Asia): 6,500,000 at 9% for 15 years
Oer 2 (Eastern Bank NL): 7,000,000 at 9.4% for 15 years
1. What would be the incremental borrowing cost of taking Oer 2 over Oer 1?
2. What would be the incremental borrowing cost if Mr. Rahman prepays whichever
loan he takes after 5 years?
3. If Brac Bank Asia charged 1.5 points on Oer 1 and Eastern Bank charged 2.5 for
Oer 2, what would be the eective incremental borrowing cost?
Answers to Case A Q1
Oer 1:
P V = 6,500,000, r = 0.09, n = 15
P MT 1
6,500,000 = × 1 −
0.09 0.09
15×12
12 1 +
12
∴ P M T = 65,927.3
Oer 2:
P V = 7,000,000, r = 0.094, n = 15 × 12 = 180
P M T = 72,673.9
Dierence in PMT = 72,673.9 − 65,927.3 = 6,796.6
If incremental borrowing cost = i:
6,796.6 1
500,000 = × 1−
i i
12×15
1 +
12
12
1
∴ i = 19.26%
Ans
Answers to Case A Q2
From Q1:
P M T1 = 65,927.3, P M T2 = 72,673.9
Balance at 5 years:
65,927.3 1 F V1
6,500,000 = × 1− +
0.09 0.09
5×12 0.09
5×12
1+ 1+
12
12 12
∴ F V1 = 52,099,19.9
Similarly:
72,673.9 1 F V2
7,000,000 = × 1− +
0.094 0.094
5×12 0.094
5×12
1+ 1+
12
12 12
∴ F V2 = 5,690,166.6
Dierence in Balance = 5,690,166.6 − 5,209,919.9 = 935,261.7 − 480,246.7
Now, incremental borrowing cost:
6,796.6 1 935,261.7
500,000 = × 1− +
i i
5×12 i
5×12
1+ 1+
12
12
12
∴ i = 19.92%
Ans
Answers to Question No. 3
With origination fees (points), money received:
P V1 = 6,500,000 × (1 − 0.015) = 6,902,500
P V2 = 7,000,000 × (1 − 0.025) = 6,825,000
Dierence = 6,825,000 − 6,902,500 = 422,500
2
6,796.6 1
∴ 422,500 = × 1−
i i
15×12
1 +
12
12
= 17.81%
CASE B
Ms. Khatun took a mortgage 4 years ago to buy a house in Bashundhara R/A. Original
loan: 11,000,000 at 10% for 25 years, monthly payments from Dutch-Bangla Bank. It has
been 9 years since.
4. Market rates have dropped. City Bank PLC oers to re nance her outstanding
balance into a new 21-year loan at 7.5%. Re nancing cost = 3% of loan +5,000
admin. What return can she expect from re nancing? What's the eective cost of
re nancing? If she borrowed the re nancing cost, what would be the eective rate?
5. If she re nances the loan after 4 years, what would be her return?
6. Instead of market rates dropping, suppose it went up 12%. The loan is now un-
derperforming for the bank. They oer her 50,000 discount if she prepays. What
would be her rate of return if she prepays?
7. If she refuses to prepayment, the bank would sell her loan. What would be the value
of her loan to a new buyer?
Answers to Question No. 4
Original loan:
P V1 = 11,000,000,
r1 = 0.10, n = 25
P MT 1
11,000,000 = × 1−
0.10 0.10
24×12
1+
12
12
P M T1 = 99,957.1
Balance at 4 years:
99,957.1 1 F V2
11,000,000 = × 1− 4×12 +
0.10 0.10 0.10
4×12
1+ 1+
12
12 12
∴ F V2 = 10,513,166.2
3
(Continued)
So borrowed amount for new loan:
P V2 = 10,513,166.2, r2 = 7.5%, n = 21
P M T2 = 82,966.3
Payments saved over the years = 99,957.1 − 82,966.3 = 16,990.8
Total cost of re nancing = 0.03 × 10,513,166.2 + 5,000 = 320,395.0
If rate of return = m:
16,990.7 1
320,395.0 = m × 1−
m 12×21
1 +
12 12
∴ m = 63.69%
If 320,395 was the cost of switch, the eective PMT would be:
(320,395 + 10,513,166) = 10,833,561
In this case PMT would be:
P M T2E = 85,499.8
But receives 10,513,166.2, and if eective cost of re nancing = irf :
85,499.8 1
10,513,166.2 = × 1−
irf irf
21×12
1 +
12
12
∴ irf = 7.89%
Eective cost = 7.89%
Now if borrower doesn't want to fund the re nancing herself, so she would be paying:
(320,395 + 320,395 + 10,513,166.2) = 11,153,956.2
In this case payment would be P M T2E ∗ :
P M T2E ∗ = 88,023.2
Eective nancing cost:
88,023 1
10,513,166.2 = × 1−
irb irb
12×21
1−
12
12
∴ irb = 8.27%
4
Answers to Question No. 5
From Q4:
P M T1 = 99,957.2, P M T2 = 82,966.3, Re cost = 320,395
P M T saving = 16,990.8
If new loan is paid 4 years early,
Balance FV of old loan at 8 years = F V8
Balance FV of new loan at 4 years = F Vii−9
Now:
99,957.1 1 F V8
11,000,000 = × 1− 4×12 +
0.10 0.10 0.10
4×12
1+ 1+
12
12 12
F V8 = 9,788,098.2
And:
82,966.3 1 F Vii−9
10,513,166.2 = × 1− +
0.075 0.075
4×12 0.075
4×12
1+ 1+
12
12 12
F Vii−9 = 9,550,528.0
Dierence of balances = 9,788,098 − 9,550,528 = 237,570
(Continued)
So if cost of re nancing = 320,395,
If m from early re nancing = inf e :
16,990.8 1 237,570.3
320,395 = × 1− +
inf e inf e
4×12 i nf e
4×12
1+ 1+
12
12
12
∴ inf e = 62.02%
Ans
5
Answer to Question No. 6
From Q4:
P M T1 = 99,957.1, Balance at 4 years = 10,513,166.2
If 50,000 is given away as discount:
Amount paid today = 10,513,166.2 − 50,000 = 10,463,166.2
So if return is i:
99,957.1 1
10,463,166.2 = × 1−
i i
12×21
1+
12
12
i = 10.07%
Return from prepayment is 10.7%, which is lower than market rate 12%. The prepayment
should not be taken.
Ans
Answers to Question No. 7
From Q4:
P M T1 = 99,957.1
Current market rate n = 12%, remaining time = 21 years.
99,957.1 1
Value of loan = 0.12
× 1− 21×12
12
1 +
12
12
= 91,81,327.7
Ans
CASE C
Mr. Hossain bought a property in Uttara 8 years ago with a mortgage of 19,000,000 at
8.5% for 25 years, monthly. The property is now worth 23,000,000 and he is selling to
Mr. Hasan. Current market rate is 11%.
8. Buyer nances 80% of value and assumes the current loan. To cover the shortfall,
he takes a second mortgage at 11% for the remaining 17 years. Find the combined
eective interest cost.
9. Mr. Hossain instead oers sellers nancing at a higher price 24,200,000 while a
standard bank would oer 18,900,000 at 11%. What would be the return for the
buyer?
6
10. For the below-market nancing, what price would the buyer be indierent to?
11. Instead, Pubali Bank oers a wraparound loan of 18,400,000 at 9.5%. What is the
incremental cost over assumption of the current loan?
12. Why would a lender still want to provide wraparound loans?
Answer to Question No. 8
Original loan:
P VA = 19,000,000, r = 8.5%, n = 25
P MT 1
19,000,000 = × 1−
0.085 0.085
25×12
1 +
12
12
P M T = 112,731.8
Balance at 8 years:
112,731.8 1 F V1
19,000,000 = × 1− +
0.085 0.085
8×12 0.085
8×12
1+ 1+
12
12 12
∴ F V2 = 12,149,000
At 80% nancing, total loan needed = 23,000,000 × 0.80 = 18,400,000
Second mortgage balance = 18,900,000 − 12,149,000 = 6,256,000 − 6,256,000
∴ P M T2 = 67,901.9
Total payments = 112,731.8 + 67,901.9 = 180,633.2
If eective cost = ic :
180,633.2 1
18,900,000 = × 1−
ic ic
17×12
1 +
12
12
∴ ic = 9.37%
Ans
7
Answers to Question No. 9
From Q8:
P M T1 = 112,731.8, F V1 = 12,149,000
For market loan:
P M TM 1
18,900,000 = × 1−
0.11 0.11
17×12
1+
12
12
P M TM = 199,710.0
Dierence in down payment:
= (24,200,000 − 12,149,000) − (23,000,000 − 18,900,000) = 7,956,000
Payment saved = 199,710 − 112,731.8 = 86,178.2 − 86,978.2
If return = rs :
86,978.2 1
7,956,000 = rs × 1−
rs 12×17
1+
12 12
∴ rs = 12.23%
12.23% > 11% market rate, so sellers nancing should be taken.
Ans
Answers to Question No. 10
Assumed loans:
Balance = 12,149,000, Payment = 112,731.8
Market value of assumed loan at 11%:
112,731.8 1
= × 1− 17×12 = 10,396,383.1
0.11 0.11
1 +
12
12
Net bene t of loan assumption = 12,149,000 − 10,396,383.1 = 1,757,616.9 − 1,752,616.9
Indierence price = 23,000,000 + 1,757,616.9 = 24,757,616.9
8
Answers to Question No. 11
With wraparound:
P VW = 18,900,000, rW = 9.5%
P M TW 1
18,900,000 = × 1−
0.095 0.095
17×12
1+
12
12
∴ P M TW = 192,119.2
Additional payment = 192,119.6 − 112,731.8 = 69,387.8
Additional balance = 18,900,000 − 12,149,000 = 6,256,000 − 6,256,000
If incremental cost = i:
69,387.8 1
6,256,000 = × 1−
i i
12×17
1+
12
12
i = 11.36%
This is close to the market rate of 11% for a second mortgage. The wraparound is in
eect another form of a second mortgage.
Answer to Question 12
The lender might still want to provide wraparound mortgages because this provides control
over the payment of the primary mortgage. The wraparound lender collects the full
payment from the borrower and then makes the payment on the underlying rst mortgage
himself, ensuring it stays current. This keeps his junior interest protected in case of
borrower default and earns him a spread between the wraparound rate and the lower rate
on the assumed rst loan.