(This is a continuation of Problem 14-53.) As inflation has increased throughout the world, the rental income of homes has decreased and a net annual rental income of 8% of the market value of the property is common. On the other hand, the market value of homes tends to rise about 2% per year more than the inflation rate. As a result, both annual net rental income, and the resale value of the property rise faster than the inflation rate. Consider the following situation.
A $150,000 property (with the house valued at $103,500 and the land at $46,500) is purchased for cash in Year 0. The market value of the property increases at a 12% annual rate. The annual rental income is 8% of the beginning-of-year market value of the property. Thus the rental income also increases each year. The general inflation rate f is 10%. he individual who purchased the property has an average income tax rate of 35%.
(a) Use MACRS depreciation, beginning January 1, to compute the actual dollar after-tax rate of return for the owner, assuming he sells the property 59 months later (in December).
(b) Similarly, compute the after-tax rate of return for the owner, after taking the general inflation rate into account, assuming he sells the property 59 months later.