Asking about Sinking fund factor (alternative)

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minhphc

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Dear all,
Could you help me to explain in reading Income property analysis- Bank of investment method,
Why do we have to adjust the capitalization rate by adding a sinking fund factor? as an example on Kaplan note, we have to plus sinking fund factor to annual mortgage cost but i do not know the reason why we have to do that. If not, what is the mistakement?
Thanks so much!
Nice day,
 
Dear Andrew, here is the example:
Assume you are estimating the value of a property that is financed 60% with a 15-year
first mortgage and 40% with equity capital. The interest rate on the mortgage is 7%
with monthly payments. The required cash on cash return on equity capital is 14%.
Compute the market capitalization rate.
Answer:
The capitalization rate to be used under the band-of-investment method, R0(BOI ), is
the weighted average cost of the individual capital components:
(mortgage weight × mortgage cost) + (equity weight × equity cost)
The annual mortgage cost is the annual interest rate plus a sinking fund factor. The
sinking fund factor in this case is the future value interest factor of an annuity of $1
at 7% per year compounded monthly for 15 years (the parameters of the loan). Using
your financial calculator, it can be calculated as:
N = 15 × 12; I/Y = 7 / 12; PV = 0; FV = –1; CPT → PMT = 0.00316 × 12 = $0.0379
I don’t know why to add sinking fund on this example. Could you help me? thank you so much!
 
I was curious about the same thing - from what I read, it looks you are adding a small payment each month which goes into a reserve fund and is used for capital improvements. It appears that nobody uses this method anymore when valuing CRE.
 
Is anyone able to replicate the calculator functions listed? I’ve tried changing the P/YR and C/YR to 12 and I still can’t get the answer provided. Thanks.
 
please never do the P/Y and the C/Y change
do a 2nd TVM on your TI BA II Plus
and enter the numbers as above.
I got the same answer as they have in the example.
Sinking Fund factor is to account for the payment of both part of the principal and the interest for the year.
 
That corrected the problem. Dividing the annual rate by 12 made me think that everything needed to be on a monthly basis. Thanks for the help.
 
So why don’t we see/use this more often? I realize it doesnt apply for most corporate debt bc it’s nonamortizing, but that’s not always the case. What about private companies that do typically have some sort of amortizing loan…I’ve never personally adjusted the cost of debt for this nor does CFAI really consider it outside of real estate relates instances. Why not more often?
 
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