Annual NOI available for debt service is $60,000 and annual debt service is $45,000. What is NOI ÷ annual debt service, rounded to two decimals?
Correct Answer
D) 1.33
60000÷45000 = 1.3333. Common errors: inverting the ratio (debt service ÷ NOI) gives 0.75; dividing the cash flow after debt service by debt service gives 0.33; reporting the cash flow after debt service as a share of NOI gives 0.25.
Why This Is the Correct Answer
Option D is correct because $60,000 ÷ $45,000 = 1.3333, which rounds to 1.33. NOI covers the annual debt service about one and one-third times.
Why the Other Options Are Wrong
Option A: 0.25
Option A, 0.25, is wrong because it expresses the cash flow after debt service as a share of NOI (($60,000 − $45,000) ÷ $60,000 = 0.25). The coverage ratio is NOI ÷ debt service = 1.33.
Option B: 0.33
Option B, 0.33, is wrong because it divides the cash flow after debt service by debt service (($60,000 − $45,000) ÷ $45,000 = 0.33). The full NOI must be divided by debt service: $60,000 ÷ $45,000 = 1.33.
Option C: 0.75
Option C, 0.75, is wrong because it inverts the ratio ($45,000 ÷ $60,000 = 0.75). The DSCR places NOI on top: $60,000 ÷ $45,000 = 1.33.
NOI on top
Coverage asks how many times income covers payments, so NOI goes on top and debt service on the bottom.
How to use: Use this to avoid inverting the DSCR.
Exam Tip
A coverage ratio below 1.0 here would mean NOI is less than debt service, which is not true with $60,000 of NOI against $45,000 of payments.
Common Mistakes to Avoid
- -Dividing debt service by NOI
- -Using cash flow after debt service as the numerator
- -Confusing coverage with the equity cash flow percentage
Concept Deep Dive
Analysis
This question tests computing the debt service coverage ratio. DSCR is NOI divided by annual debt service. With NOI of $60,000 and debt service of $45,000, the ratio is about 1.33.
Background Knowledge
Lenders use the debt service coverage ratio to measure how comfortably a property's NOI can pay its loan. A ratio above 1.0 means NOI exceeds annual debt service. Minimum acceptable ratios depend on lender standards and property risk.
Real-World Application
A lender reviewing a refinance compares the appraiser's estimated NOI to the proposed annual loan payments. A coverage ratio of about 1.33 shows income exceeds payments by a third.
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