. Jamie Thompson is thinking about investing in some residential income-producing property that she can purchase for $200,000. Jamie can either pay cash for the full amount of the property or put up $50,000 of her own money and borrow the remaining $150,000 at 8% interest. The property is expected to generate $30,000 per year after all expenses but before interest and income taxes. Assume that Jamie is in the 28% tax bracket. Calculate her annual profit and return on investment assuming that she (a) pays the full $200,000 from her own funds or (b) borrows $150,000 at 8%. Then discuss the effect, if any, of leverage on her rate of return. (Hint: Earnings before interest & taxes minus Interest expenses (if any) equals Earnings before taxes minus Income taxes (@28%) equals Profit after taxes.)

Interest at 8% <~~??

Your textbook needs to catch up to the times!
http://www.mortgagenewsdaily.com/mortgage_rates/

To calculate Jamie Thompson's annual profit and return on investment in both scenarios, we will follow these steps:

1. Calculate the annual profit when Jamie pays the full $200,000 from her own funds:
a. Earnings before interest and taxes (EBIT) = $30,000
b. Interest expenses = $0 (since Jamie pays in full with cash)
c. Earnings before taxes (EBT) = EBIT - Interest expenses = $30,000
d. Income taxes (@28%) = EBT * 0.28 = $8,400
e. Profit after taxes = EBT - Income taxes = $30,000 - $8,400 = $21,600

2. Calculate the annual profit when Jamie borrows $150,000 at 8%:
a. EBIT remains the same at $30,000
b. Interest expenses = Borrowed amount * Interest rate = $150,000 * 0.08 = $12,000
c. EBT = EBIT - Interest expenses = $30,000 - $12,000 = $18,000
d. Income taxes (@28%) = EBT * 0.28 = $18,000 * 0.28 = $5,040
e. Profit after taxes = EBT - Income taxes = $18,000 - $5,040 = $12,960

3. Calculate the return on investment (ROI):
a. ROI = Profit after taxes / Investment * 100
b. Investment when paying in full = $200,000
c. ROI when paying in full = $21,600 / $200,000 * 100 ≈ 10.8%
d. Investment when borrowing = $50,000 (Jamie's own funds) + $150,000 (borrowed amount) = $200,000
e. ROI when borrowing = $12,960 / $200,000 * 100 ≈ 6.48%

Now let's discuss the effect of leverage on Jamie's rate of return:

Leverage refers to borrowing money to invest instead of using only your own funds. In Jamie's case, when she borrows $150,000 at 8% interest, her ROI decreases to 6.48% compared to 10.8% when paying in full from her own funds.

The effect of leverage on ROI is that it magnifies the returns on the investment. In this case, borrowing allows Jamie to invest a larger amount and potentially generate higher profits. However, the interest expenses reduce the overall profit, thereby decreasing the ROI.

It's important to consider the risks associated with leverage, such as fluctuations in interest rates or potential changes in the property market. Higher leverage can lead to higher returns, but it also increases the potential for larger losses if the investment doesn't perform well. It's essential to carefully assess the risks and rewards before deciding to use leverage in an investment.