Question

You are making a buying-vs-renting decision. You have the following information:

The house you like costs $300,000. You expect home values to increase by 3% every year. Property taxes: 2% of house value, due at the end of each year. (In other words, the property taxes due at the end of year 1 are based on the house value in year 0.) Maintenance: $1,000 per year. You would take a home mortgage loan with an LTV of 80%. Loan information: 30-year term, fully amortizing with fixed annual payments, 5% annual interest rate, remaining balance due upon house sale. When you sell the house the estimated selling expenses are $5,000, and you expect no capital gain taxes.

If you instead rent a house just like this one, you’d be paying $12,000 on rent every year.

Your income puts you in a 25% income tax bracket.

Calculate the after-tax cash flows if you buy rather than rent. Use them to calculate the after-tax Internal Rate of Return (ATIRR).

(a) If you can earn a 15% annual return on other investments, investing your money into this house and selling it after 2 years is a____ (good or bad) idea financially. That's because the calculated IRR is___ (greater than or lower than) the 20% required annual return. The calculated after-tax IRR equals____?

(b) If you can earn a 15% annual return on other investments, investing your money into this house and selling it after 3 years is a ___ (good or bad) idea financially. That's because the calculated IRR is____ (greater than or lower than) the 15% required annual return. The calculated after-tax IRR equals____?

(c) Using 15% as your required return, in order for you to be indifferent between buying and not buying for 3 years, the LTV needs to approximately equal____?

Answer 1