An investor’s initial cash equity investment is $100,000. The property generates annual before-tax cash flow to that equity of $12,000 after debt service. What is the annual equity dividend (cash-on-cash) rate, rounded to two decimal places?
Correct Answer
B) 12.00%
Annual equity cash flow divided by initial cash equity is $12,000 ÷ $100,000 = 0.12. Multiplying by 100 gives 12.00%. This is the current annual cash-on-cash rate, not an internal rate of return or a total return that includes appreciation and sale proceeds.
Why This Is the Correct Answer
Option B is correct because $12,000 / $100,000 = 0.12, and 0.12 x 100 = 12.00%. This is the current annual cash-on-cash rate. It is not an internal rate of return or a total return including appreciation and sale proceeds.
Why the Other Options Are Wrong
Option A: 0.12%
Option A is wrong because 0.12% labels the decimal 0.12 as a percentage without multiplying by 100. The correct calculation is $12,000 / $100,000 = 0.12, which is 12.00%.
Option C: 8.33%
Option C is wrong because 8.33% comes from inverting the ratio: $100,000 / $12,000 = 8.33, then reading that factor as a percentage. The correct rate is $12,000 / $100,000 = 12.00%.
Option D: 120.00%
Option D is wrong because 120.00% is ten times too high, as if $12,000 were divided by $10,000 instead of $100,000, a decimal-place slip. The correct rate is $12,000 / $100,000 = 12.00%.
Cash out over cash in
Cash-on-cash is the cash you receive this year divided by the cash you put in.
How to use: Use this to set up the equity dividend rate with the cash flow on top and the equity investment on the bottom.
Exam Tip
Sanity-check the size of the answer: a $12,000 annual return on $100,000 is a moderate rate, so tiny or triple-digit percentages signal a decimal or inversion error.
Common Mistakes to Avoid
- -Forgetting to convert the decimal to a percentage
- -Dividing equity by cash flow
- -Confusing cash-on-cash with an internal rate of return
Concept Deep Dive
Analysis
This question tests the equity dividend rate, also called cash-on-cash return. It is annual before-tax cash flow to equity divided by the initial cash equity investment. Here $12,000 / $100,000 = 0.12, which is 12.00% when expressed as a percentage.
Background Knowledge
The equity capitalization or equity dividend rate measures annual pre-tax cash flow to equity relative to the equity invested. It reflects only the current year's cash return, not appreciation, loan amortization or sale proceeds. It is a key input in band-of-investment and mortgage-equity analysis.
Real-World Application
An investor puts $100,000 down on a small rental and nets $12,000 after debt service in the first year. The appraiser compares this 12% equity dividend rate with rates investors accept on similar properties when building a band-of-investment capitalization rate.
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