Annual NOI available for debt service is $110,000 and annual debt service is $85,000. What is NOI ÷ debt service, to two decimals?
Correct Answer
D) 1.29
110000÷85000 = 1.29. Common errors: inverting the ratio (debt service ÷ NOI) gives 0.77; dividing the cash flow after debt service by debt service gives 0.29; reporting the cash flow after debt service as a share of NOI gives 0.23.
Why This Is the Correct Answer
Option D is correct because $110,000 / $85,000 = 1.294, which rounds to 1.29. This shows NOI covers the annual debt service about 1.29 times.
Why the Other Options Are Wrong
Option A: 0.23
Option A, 0.23, is ($110,000 - $85,000) / $110,000, the cash flow after debt service as a share of NOI. The ratio asked for is NOI / debt service = $110,000 / $85,000 = 1.29.
Option B: 0.29
Option B, 0.29, is ($110,000 - $85,000) / $85,000, which divides the cash flow after debt service by debt service. The correct ratio uses the full NOI: $110,000 / $85,000 = 1.29.
Option C: 0.77
Option C, 0.77, inverts the ratio: $85,000 / $110,000. Debt service coverage is NOI divided by debt service, $110,000 / $85,000 = 1.29.
Income over obligation
Coverage means income covers debt, so income sits on top: NOI over debt service.
How to use: Use this to set up the fraction correctly before dividing.
Exam Tip
When NOI is larger than debt service, the coverage ratio must be above 1, so answers below 1 signal an inverted or misdefined ratio in this setup.
Common Mistakes to Avoid
- -Dividing debt service by NOI
- -Using cash flow after debt service in the numerator
- -Using EGI instead of NOI
Concept Deep Dive
Analysis
This question tests the debt service coverage ratio, which is NOI divided by annual debt service. The order of division matters: NOI goes on top, so a property whose NOI exceeds its debt service has a ratio above 1.
Background Knowledge
The debt service coverage ratio compares the NOI a property produces with the annual mortgage payments it must support. Lenders use it to gauge how much cushion income provides above the debt payment. It also appears in the debt coverage formula for an overall rate, Ro = DCR × M × Rm.
Real-World Application
A lender's review appraiser checks that a proposed loan on a fourplex would leave NOI of about 1.29 times the annual payment. The appraiser reports the NOI and the lender applies its own underwriting threshold.
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