Question

Project 1: 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.

PLEASE SHOW THE FORMULAS- THANK YOU!!

Answer 1

The Net Present Value of buying the house over renting the house is $25,836.70. Thus, Samuel has to buy the house instead of renting as he will save $25,836.70 in present value.

Workings:

Note:

1. Insurance and property tax are assumed to be tax deductible. While property taxes can be deducted for tax purposes, insurance typically are not tax deductible. Since there is no break-up given between these costs, entire costs are assumed tax deductible.

2. Interest and rental payments are tax deductible

3. After the house is sold in year 5, the outstanding principal on the loan needs to be repaid.