Do not be fooled by the trap answers of 10% or 50%! The correct solution is NOT the
$ 12,000 appreciation divided by the cost of the $120 000 original investment (i e 10%) Furthermore the correct answer is NOT $12 000 appreciation divided by the equity the $120,000 original investment (i.e.
1 0%). Furthermore, the correct answer is NOT $12,000 appreciation divided by the equity stake of
$ 24,000 (i.e.50%). The correct answer requires that cash flow return be divided by the equity in the investment. Candidates should quickly determine that the equity in the investment is 20% of the $120,000 purchase price or $24,000. However, in order to compute the true ROI, analysts need to adjust the appreciation for related financing expenses.
Since the property appreciated $12,000, the cash flow from the property is the $12,000 appreciation less interest of $8,640 ($120,000 X .80 X .09). Thus, her cash flow for the year was not $3,360, not $12,000.
The $3,360 increase in cash flow divided by her original $24,000 equity stake provided a return of 14%.