Question

Project: Buy or Rent?

Project description Samuel just moved to Radford and plans to live here for 5 years. He just found a “perfect” house to live in with his family. The current owner is willing to sell or rent the house to Samuel. The selling price will be $300,000. Samuel has $60,000 for down payment and is eligible for a 30-year 4% fixed -rate mortgage loan to finish the purchase. If Samuel owns the house, he needs to pay $3,000 annually for insurance and property tax, and expects to sell the house for the same price ($300,000) when he leaves Radford at the end of year 5. If Samuel rents the house, the annual rent will be $24,000. Samuel is confident that he can have an annual after-tax investment return of 5% over the next five years. Samuel’s personal tax rate is 20%.

Ignore the transaction costs associated buying and selling the house and assume that all the expenses, payments, and investment payoffs occur at the end of the year. Should Samuel buy or rent the house? If Samuel makes the right choice, how much can he save in terms of the present value?

Requirements:

1. Present the case solution in an Excel file with clear labels, functions and descriptions.

2. Starting with the data provided, show each step of your work that leads to the conclusion.

3. Due in D2L by 11:59PM Sunday May 24.

Hints:

1. In Excel, you may need functions: PMT(rate,nper, pv, fv)

2. Renting can save the down payment which can be used for investment. However, renting is also costly and Samuel will not get any equity value of the house at the end of year 5. Buying costs more now and entails subsequent mortgage payments and other costs of ownership, but Samuel can get some equity value at the end of year 5 (which can be inferred from the loan amortization schedule).

3. Another benefit of buying is that the interest payments can save tax for Samuel. Each year’s interest payment can be seen in the loan amortization schedule.

Grading:

7 points in total

Finished and submitted on time: 3 points

0-25% correct: +1

25%-50% correct: +2

50%-75% correct: +3

75%-100% correct: +4

***This is all the information given from the Professor***

Answer 1

Renting is more beneficial

Because Cash outflow in buying option is - 206019.99

And in Renting option cash outflow is - 43907.44

Saving in Present value of cash flow 162922.55

Therefore rent the house rather than buy.

Assumed loan for 30 years repayment in equal installments. Installment = (300000 - 60000)/ 30 =8000.

But if the house sold at the end of 5 years then remaining principal amount of loan has to be repaid at the end of 5 years

Notes : equal to sign (=) should be used before formula given in excel sheet (ex. =PV(C4,C3,0,C10)

Rate of return = 5% for 5years for PVAF

Interest rate considered on investment of down payment =5%

Tax shield on expenses and interest payment by applying PV factor@ 5% .

Present value in case of Rent option calculated by PV factory*( annual rent less interest on investment )

Assumed that investment of 60000 for 5 years.