Question

1. Racine is thinking of buying a new home. Currently, she owns an older home that costs her approximately $11,000 a year. The cost of the new home is $150,000. She can obtain a $120,000 mortgage for 30 years at 4% interest. The home has no homeowner’s association dues. Annual costs for property taxes, hazard insurance and estimated landscaping/maintenance is approximately $450, $1,000, and $600. She estimates that she will live in the home for six years and resell it for $185,000. Racine’s discount rate is 7%.

Is this a good investment according to NPV? IRR?

Answer 1

Computation of NPV
Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Cash inflows :
Savings in cost of old home		$11,000	$11,000	$11,000	$11,000	$11,000	$11,000
Resale price of house							$185,000
Total inflows		$11,000	$11,000	$11,000	$11,000	$11,000	$196,000
Cash outflows :
Upfront payment for house	$30,000
Taxes, insurance and maintenance costs		$2,050	$2,050	$2,050	$2,050	$2,050	$2,050
Interest costs		$      4,800	$      4,640	$      4,480	$      4,320	$      4,160	$      4,000
Principal payment		$4,000	$4,000	$4,000	$4,000	$4,000	$4,000
Total outflows	$30,000	$10,850	$10,690	$10,530	$10,370	$10,210	$10,050
Net cash inflow/(outflow)	($30,000)	$150	$310	$470	$630	$790	$185,950
Discount factor	1	0.9345794	0.8734387	0.8162979	0.7628952	0.7129862	0.6663422
Present value of net inflows	($30,000)	$140	$271	$384	$481	$563	$123,906
NPV	$95,745

Yes, the project is profitable as per NPV and IRR