The Effects of Financing on Investor's Equity

D

Remember that, in real estate, the use of debt financing to purchase a piece of property will affect its risk-return parameters. In this case, leverage has a positive effect.

To determine the effects being experienced by the investor, we need to understand the concept of leverage and how it affects returns on equity.

Leverage refers to the use of borrowed funds to finance an investment. It magnifies the potential returns and risks of an investment. When an investor borrows money to invest, it is called positive leverage. Conversely, when an investor does not borrow money and invests solely with their own funds, it is called negative leverage or unleveraged.

In this question, we are given two scenarios:

1. Return on Investor's Equity with 80% Financing = 50%
2. Return on Investor's Equity with 0% Financing = 10%

The investor's equity is the amount of money the investor has contributed to the investment, while financing represents the borrowed funds.

Now, let's analyze the returns in each scenario:

1. Return on Investor's Equity with 80% Financing = 50%: This means that the investor's equity is responsible for generating a return of 50% on the total investment. The remaining 30% return (50% - 20% investor's equity) is generated by the borrowed funds. In this case, the investor is experiencing positive leverage because the return on equity is higher than it would have been without borrowing funds.

2. Return on Investor's Equity with 0% Financing = 10%: In this scenario, the investor is not using any borrowed funds and is solely relying on their own equity. The return on equity is 10%, which is the total return generated by the investment. Here, there is no leverage involved, and the return on equity is lower compared to the leveraged scenario.

Based on the above analysis, the investor is experiencing the effects of positive leverage. Therefore, the correct answer is (D) positive leverage.