A property has an NOI of $125,000 and annual debt service of $95,000. If the loan amount is $1,100,000, what is the debt coverage ratio?
Correct Answer
A) 1.32
Debt coverage ratio = NOI ÷ Annual debt service = $125,000 ÷ $95,000 = 1.32.
Why This Is the Correct Answer
Option A is correct because the debt coverage ratio formula is simply NOI divided by annual debt service. Using the given values: $125,000 ÷ $95,000 = 1.3157, which rounds to 1.32. This calculation shows the property generates 1.32 times the income needed to cover debt payments, indicating healthy cash flow. The loan amount of $1,100,000 is not used in the DCR calculation - it's included as a distractor.
Why the Other Options Are Wrong
Option B: 0.76
Option B (0.76) represents the inverse calculation of annual debt service divided by NOI ($95,000 ÷ $125,000), which is mathematically incorrect for debt coverage ratio. This would indicate the property cannot cover its debt obligations, which contradicts the actual positive cash flow situation.
Option C: 11.58
Option C (11.58) appears to result from dividing the loan amount by annual debt service ($1,100,000 ÷ $95,000), which is not the correct DCR formula. This calculation has no meaningful financial interpretation in the context of debt coverage analysis.
Option D: 1.16
Option D (1.16) seems to result from an error in calculation or potentially dividing NOI by the loan amount and multiplying by some factor. This does not follow the standard debt coverage ratio formula and would understate the property's actual debt coverage capability.
NOI Over Debt Service
Remember 'NOD' - NOI Over Debt service. Think 'NOD your head YES when NOI is higher than debt service payments.'
How to use: When you see a DCR question, immediately identify NOI and annual debt service, then think 'NOD' to remember NOI goes on top of the fraction.
Exam Tip
Ignore any loan amount given in DCR questions - it's typically a distractor. Focus only on NOI and annual debt service for the calculation.
Common Mistakes to Avoid
- -Using loan amount in the calculation instead of annual debt service
- -Calculating the inverse ratio (debt service ÷ NOI)
- -Confusing annual debt service with monthly payments
Concept Deep Dive
Analysis
The debt coverage ratio (DCR) is a critical financial metric used by lenders to assess a property's ability to generate sufficient income to cover its debt obligations. It measures how many times the property's net operating income can cover the annual debt service payments. A DCR above 1.0 indicates the property generates enough income to cover debt payments, while below 1.0 suggests potential cash flow problems. Lenders typically require a minimum DCR of 1.20-1.25 for commercial real estate loans to ensure adequate cushion for payment security.
Background Knowledge
Debt coverage ratio is calculated as Net Operating Income divided by Annual Debt Service, expressed as a decimal or ratio. Lenders use this metric to evaluate loan risk, with higher ratios indicating better ability to service debt obligations.
Real-World Application
Appraisers often calculate DCR when valuing income-producing properties for lending purposes, as it helps determine if the property can support proposed financing and influences loan approval decisions.
More Math & Stats Questions
What is the area of a triangular lot with a base of 120 feet and a height of 80 feet?
An irregular lot has the following measurements: Side A = 100', Side B = 150', Side C = 120', Side D = 180'. If the lot can be divided into two rectangles (100' × 150' and 120' × 30'), what is the total area?
A property has a potential gross income of $180,000, vacancy and collection loss of 7%, and operating expenses of $65,000. What is the NOI?
A property generates $120,000 in net operating income and is valued at $1,500,000. What is the capitalization rate?
A building has potential gross income of $180,000, vacancy and collection loss of 8%, and operating expenses of $54,000. What is the net operating income?
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