2. (30%) Now consider the case where they take out a mortgage to finance the investment. The point of this case is to get you to think about the effect of financing on returns. It should also lead to a discussion of the relation between financing and risk. Case facts: Sally and Dave intend to take a 10-year mortgage for $50,000. The mortgage has interest rate of 8%, compounded annually. Repayment of the mortgage is in equal annual payments of interest and principal. Sally and Dave can rent out the condo for $2,000 per month. Theyll have to pay property taxes of $1,500 annually and theyre figuring on additional miscellaneous expenses of $1,000 per year. All the income from the condo has to be reported on their annual tax return. Currently Sally & Dave have a tax rate of 30%, and they think this rate will continue for the foreseeable future. The full cost of the condo can be depreciated over 25 years on a straight-line basis. To calculate the return from owning the condo, Sally and Dave assume that they will sell the condo at the end of 10 years for $100,000. Any gain over book value on the sale is taxable. Calculate Sally and Daves IRR on their equity investment. (Terminology: Since the cost of the condo is $100,000 and since theyre borrowing $50,000, the equity investment is $50,000.) Remember that for income tax purposes depreciation and interest on the mortgage are expenses, but that repayment of mortgage principal is not an expense. 3. (10%) Show (in a data table) the effect on the equity IRR when the mortgage goes from $0, $10,000, $20,000, ... , $90,000. Explain your results. 4. (10%) Show (in a data table) the effect on the equity IRR when the tax rate varies from 0% to 40% (in steps of 5%). 5. (20%) Suppose that Sally and Dave take a $50,000 mortgage with a 25-year term. They still plan to sell the apartment at the end of year 10. At this date they will repay the remaining mortgage principal with a 2% penalty for early repayment. Calculate the equity IRR. 6. (10%) Conclusions. Suppose that Sally and Dave can afford to buy a condo without borrowing. However one of their priorities is IRR. In 7-10 sentences discuss their best strategy and what kind of advices you can give them if they decide to talk to a bank about potential mortgage.