Modeling Test/Practice Questions About Financing
A couple questions for modeling test practice:
1) Is the loan origination fee/financing fee typically funded by equity?
2) If your operating cash flow cannot cover debt service in any year, how is the overrun handled? If you set up a reserve to cover the deficit, is that typically funded by equity (if so, is it set aside at the time of purchase or called as needed) or rolled into the total cost basis at acquisition so that some of it is covered by the loan?
2a) In the scenario above, if there is capex in Y1 that can be covered by the property cash flows, but depletes the income enough that the debt service cannot be paid, would the capex typically be funded at acquisition so that the debt service can be covered by NOI?
Hopefully those make sense. Thanks!
Based on the most helpful WSO content, here's a detailed breakdown of your questions regarding financing in financial modeling tests:
1) Loan Origination Fee/Financing Fee Funding: Typically, the loan origination fee or financing fee is not funded by equity. Instead, these fees are usually paid upfront and can be financed as part of the loan amount, depending on the lender's terms. This means that the fee increases the total loan amount rather than being paid out of pocket by equity.
2) Handling Overruns When Operating Cash Flow Can't Cover Debt Service: - If operating cash flow is insufficient to cover debt service, a reserve account might be set up to handle the deficit. This reserve is typically funded by equity, and it can be set aside at the time of acquisition or called as needed, depending on the agreement and the financial planning of the investment. - The reserve might also be included in the total cost basis at acquisition, allowing part of it to be covered by the loan, depending on how the financial structure is set up and the lender's policies.
2a) Handling CapEx and Debt Service: - In a scenario where there is capital expenditure (CapEx) in Year 1 that can be covered by property cash flows but depletes the income to a level where debt service cannot be paid, the typical approach would be to fund the CapEx at acquisition. This strategy ensures that the net operating income (NOI) is sufficient to cover the debt service. By doing so, the initial financial setup would include the CapEx in the total loan amount or have it covered by additional equity injected at acquisition to maintain liquidity for debt service.
These strategies are crucial for maintaining financial stability and ensuring that the investment can withstand cash flow variances without jeopardizing debt obligations.
Sources: https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare-for-restructuring-technical-questions?customgpt=1, CMBS B-Piece Buyers, Calling all people in Development, How to Prepare for Restructuring Technical Questions, How do you compute IRR without any negative cash flows?
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