An investor purchases a property for $400,000 with $100,000 down payment. The property generates $8,500 annual cash flow after debt service. What is the equity dividend rate?
Correct Answer
A) 8.5%
Why this is correct: Equity Dividend Rate (aka Cash-on-Cash Return) = Annual Cash Flow Before Tax / Equity Investment. Calculation: $8,500 / $100,000 = 0.085. Convert to percentage: 0.085 * 100 = 8.5%. Why the other choices are wrong: 4.7% results from dividing by the total price ($400,000). 2.125% incorrectly uses monthly cash flow or a miscalculation. 21.25% is 8.5% * 2.5, a common multiplication error. Exam tip: Equity Dividend Rate uses the investor's *down payment* (equity), not the total property price, in the denominator.
Why This Is the Correct Answer
Option B is correct because the equity dividend rate formula is Annual Cash Flow ÷ Equity Investment. The investor's equity investment is the down payment of $100,000, and the annual cash flow after debt service is $8,500. Dividing $8,500 by $100,000 equals 0.085 or 8.5%. This represents the annual return the investor receives on their actual cash invested in the property.
Why the Other Options Are Wrong
EDDIE Formula
EDDIE = Equity Dividend = Dollars In Equity. Remember 'Eddie gets Dividends on his Investment Equity' - Annual cash flow Dividends divided by Initial Equity investment.
How to use: When you see equity dividend rate questions, think 'EDDIE' and remember to divide the annual cash flow by the DOWN PAYMENT (equity), never the total purchase price.
Exam Tip
Always identify what the investor actually paid in cash (down payment) as the denominator - don't use the total property value.
Common Mistakes to Avoid
- -Using total property value instead of equity investment in the denominator
- -Confusing equity dividend rate with overall return on investment
- -Using gross income instead of cash flow after debt service
Concept Deep Dive
Analysis
The equity dividend rate (also called cash-on-cash return) measures the annual return an investor receives on their actual cash investment in a property. This metric is crucial for comparing investment opportunities because it shows the percentage return based on the equity invested, not the total property value. It helps investors evaluate whether their cash investment is generating adequate returns compared to alternative investments. The calculation focuses solely on the relationship between annual cash flow after debt service and the initial equity investment.
Background Knowledge
Equity dividend rate is a key investment analysis metric that measures cash-on-cash return for leveraged real estate investments. It differs from overall return on investment because it specifically measures returns relative to the investor's actual cash equity, not the total property value.
Real-World Application
Appraisers use equity dividend rates when preparing investment analysis for clients comparing multiple properties, helping investors understand which property provides better returns on their actual cash investment rather than just gross returns.
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