technical question interview
Hi,
Found this interview post by a fellow monkey in one of the interview insights. I know that there is info lacking in the question, but can someone help me try to figure out the solution here/overall message?
Question: 1. If you had 2 million to buy a house and the bank was willing to lend 100k at 1%, 200k at 2%, 300k at 3% etc. How much would you borrow?
Solution: "Required guidance to answer the initial question, and interviewer helped me walk through it. Initial response was that if my required rate of return was 7% then I should borrow 699.99k at 6.99%. He said that this was wrong and to think about it as what is the cost of each 100k of incremental borrowing. I.e. you pay 1,000 for 100k borrowed, 4k for 200k borrowed, which is 3k more interest for the additional 100k of debt, or 3% interest. Solve the question from ther"
bump
bump - great question
Bump, cool question
bump
Need to find projected CF with funds used outside purchase. Say you borrow 500K at 5%, 25K in interest and 17K in principal using back of the napkin math. Give or take around 42K in debt service annually - with 500K left over need to generate 8.4% return if you invested the capital into bonds or equities annually to meet the debt service.
If you can generate over 8.4%, then best use of capital is to lever up and generate excess cash flow. That’s my initial read.
where do you get the 8.4% from? how does this reconcile with the lead given by the interviewer as stated in the question?
DS over amount of capital invested
that does not equal 8.4%? shouldn't the return on equity by calculated as (appreciation + any inflows of cash + debt paydown)/initial equity outlay? You are not looking at the return on the equity you invested but the equity that is left over..
Step 1: clarify objective
You need to clarfy the goal of the question first, so ask: what is my goal? Is this buy-and-let or to live in myself? (i.e.: is there rent income to service the loan)
Solution: marginal interest rate
As there is something said about the 7% IRR requirment: if you go from 300 to 400k, your interest expense grows from 9 to 16k so delta of 7k. On 100k, that is 7%. Probably interviewer is looking for this in the answer as the marginal intereste expense is exceeding IRR. With every additional 100k this becomes worse (9%, 11%, etc).
Hey Rover,
Thanks for the answer - don't have more info. not entirely sure I follow though. even if the interest expense would be 6% or above 7%, how does that get us to 7% IRR? why are we looking at incremental 100k? what in your view given the limited info would be the most reasonable answer?
7% hurdle comes from the solution part of the initial post
It’s a dumb question but the point is you have a bespoke credit that can be disassembled into 100k-sized incremental tranches offering different pricing. The catch is that a 400k at 4% loan can be viewed as a 100k loan at 1%, another 100k loan at 3%, another 100k loan at 5% and another 100k loan at 7%. This is different from a vanilla 400k loan at 4% that does not have the option to disassemble. Why’s it different? Because not only you are offered the 400k at 4% but more importantly simultaneously you are offered the 300k at 3% and the (n-1)100k at (n-1)% palette so you can pick your own size and pricing.
Given this bespoke structure, you compare to your hurdle rate (say it’s 6% IRR) and therefore you choose to take 300k at 3% as the 400k at 4% is viewed as an incremental 100k at 7% which exceeds your 6% cost/financing cap.
This is a dumb question and is only there to prod you into thinking about “marginal” allocation.
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