CHAPTER 4 MINI-CASE: SALLY AND DAVE'S CONDO-FINANCING WITH A MORTGAGE This version: April 2011 Overview This mini-case takes us back to b-school grads Sally and Dave. You'll perhaps recall from PFE Chapter 4 that they're thinking of buying a condo which will cost $100,000. In Chapter 4, Sally and Dave were planning to finance the condo purchase without borrowing. In this case we 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 Here are the 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. They'll have to pay property taxes of $1,500 annually and they're 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, of course, taxable