Annual NOI available for debt service is $85,000 and annual debt service is $68,000. What is NOI ÷ debt service, rounded to two decimals?
Correct Answer
D) 1.25
85000÷68000 = 1.25. Common errors: inverting the ratio (debt service ÷ NOI) gives 0.80; dividing the cash flow after debt service by debt service gives 0.25; reporting the cash flow after debt service as a share of NOI gives 0.20.
Why This Is the Correct Answer
Option D is correct because DSCR = NOI ÷ debt service = $85,000 ÷ $68,000 = 1.25. NOI covers annual debt service 1.25 times.
Why the Other Options Are Wrong
Option A: 0.20
Option A, 0.20, divides cash flow after debt service by NOI: ($85,000 − $68,000) ÷ $85,000 = 0.20. The question asks for NOI ÷ debt service, which is 1.25.
Option B: 0.25
Option B, 0.25, divides cash flow after debt service by debt service: ($85,000 − $68,000) ÷ $68,000 = 0.25. That is the coverage margin above 1.0, not the ratio itself, which is 1.25.
Option C: 0.80
Option C, 0.80, inverts the ratio: $68,000 ÷ $85,000 = 0.80. The DSCR places NOI on top: $85,000 ÷ $68,000 = 1.25.
Income over obligation
Put what the property earns (NOI) over what it owes the lender (debt service).
How to use: Use it to set up the DSCR with NOI in the numerator.
Exam Tip
When NOI exceeds debt service, the DSCR is greater than 1.0, so answers below 1.0 fail a quick check.
Common Mistakes to Avoid
- -Dividing debt service by NOI
- -Using cash flow after debt service in the numerator
- -Confusing the coverage margin with the coverage ratio
Concept Deep Dive
Analysis
This question tests the debt service coverage ratio, which is NOI divided by annual debt service. The ratio shows how many times NOI covers the required loan payments. Distractors invert the ratio or use cash flow after debt service.
Background Knowledge
The debt service coverage ratio is calculated by dividing NOI by annual debt service requirements. Lenders use it to judge whether a property's income can support a loan; a ratio above 1.0 means NOI exceeds debt service.
Real-World Application
A lender reviewing an appraisal of a small apartment building compares the appraiser's stabilized NOI to proposed annual loan payments. The resulting DSCR helps the lender decide whether the loan amount is supportable.
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