Question
You have just purchased a building to house your startup. In order to provide certainty with respect to monthly cash-flow you have financed it with
You have just purchased a building to house your startup. In order to provide certainty with respect to monthly cash-flow you have financed it with a 15 year fixed rate mortgage loan at an annualized rate of 5%. Your initial and current loan balance is $500,000 and you plan to be in this building for 4 years. In addition, assume you face a marginal tax rate of 20% and you expect to have taxable income.
a. Assume the day after closing on this loan you meet with a financial analyst who advises you that your rate is too high and that she can provide you with a lower rate if you refinance immediately. The cost of refinancing is $5,000. How much lower must the rate be to make you indifferent between refinancing and staying in your current mortgage? Assume that you will sell this building after 4 years in order to expand. Build a spreadsheet model to answer this question that allows you to change the inputs and answer a similar question with different assumptions.
b. Does your answer change if the initial value of your loan is $400,000? What is the new rate that makes you indifferent between refinancing and holding your current mortgage?
c. How does uncertainty with respect to how long it will be before you sell the building affect your decision? How might you model this? Explain your answer carefully.
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