Question
This project requires you to compare renting versus owning a home. Assume a property can be rented for $13,200 per year ($1,100 per month) or
This project requires you to compare renting versus owning a home. Assume a property can be rented for $13,200 per year ($1,100 per month) or purchased for $160,000 with $30,000 down and financed with a fully amortizing mortgage loan of $130,000 at 3 percent interest for 30 years. Other costs associated with owning include maintenance costs of $500, insurance costs of $500, and property taxes of 3 percent of the purchase price. Assume the federal income tax rate is 22 percent. Growth rates for expenses (insurance, maintenance, property taxes), rents, and property value are a constant 2 percent per year. After five years, the property will be sold. Selling expenses of 5 percent would have to be paid at that time.
Be sure to show your work in Excel. In other words, do not simply type values into the boxes, but reference prior cells when calculating results. In your report, identify how much money is saved from owning relative to renting after selling the house in year 5. If an annual after-tax return of 15 percent is available on an investment of comparable risk, which is the better option, owning or renting?
Part 3: Cash Flow Analysis
Fill in the cash flow tables. Property taxes in year 1 are calculated as purchase price * property tax rate. Property taxes in future years grow at 2 percent per year. Note that tax deductions include property taxes and interest. Tax savings are calculated as total tax deductions * income tax rate. After-tax cash flows are calculated as tax savings cash outflows before taxes. After tax cash flows from owning are calculated as after-tax cash flows + rent saved. Before-tax cash flow from sale can be calculated property value selling costs mortgage balance. The after-tax cash flow from sales are identical to the before-tax cash flow from sales due to exclusions. (25 points)
Part 3) Cash Flow Analysis | |||||||
Before-Tax Cash Flows-Owner | |||||||
Year | 1 | 2 | 3 | 4 | 5 | ||
Property taxes | Hint: Use the FV formula for one period | ||||||
Insurance | Hint: Use the FV formula for one period | ||||||
Maintenance | Hint: Use the FV formula for one period | ||||||
Principal and Interest | Hint: The annual payment on the loan | ||||||
Cash Outflows before taxes | Hint: Sum the values above | ||||||
Tax Deductions-Owner | |||||||
Year | 1 | 2 | 3 | 4 | 5 | ||
Property taxes | Hint: Reference same values calculate above | ||||||
Interest | Hint: Reference same values from the yearly summary loan schedule | ||||||
Total tax deductions | Hint: Sum of property taxes and interest | ||||||
Tax savings | Hint: Total tax deductions * income tax rate | ||||||
Rents | |||||||
Year | 1 | 2 | 3 | 4 | 5 | ||
Rents | Hint: Reference same values from yearly property data above | ||||||
Net Cash Flows-Owning | |||||||
Year | 1 | 2 | 3 | 4 | 5 | ||
Cash outflows before taxes | Hint: Reference from above | ||||||
Tax savings | Hint: Reference from above | ||||||
After-tax cash flows | Hint: Tax savings - cash outflows before taxes | ||||||
Rent saved (Rents) | Hint: Reference from above | ||||||
After tax cash flows-owning | Hint: After-tax cash flows + Rent saved | ||||||
Before-Tax Cash Flows-Sales | |||||||
Year | 1 | 2 | 3 | 4 | 5 | ||
Property value | |||||||
Selling costs | |||||||
Mortgage balance (Balance) | |||||||
Before-tax cash flow from sale | |||||||
After-tax cash flow from sale | Hint: Same as before-tax cash flow from sale, due to tax exclusions | ||||||
Cash Savings and IRR | |||||||
Years | 0 | 1 | 2 | 3 | 4 | 5 | IRR |
Cash flow | |||||||
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