Case Study 1 - Group 2

Time Value of Money: The Buy Versus Rent Decision

Input:
Asking Sales Price: $620,000
Final Sales Price: $600,000
Down Payment (20%): $120,000
Actual Mortgage: $480,000
Taxes due today: $18,000
Closing fees due today: $2,000

1) Monthly payment for mortgage:

The number of payments that will occur can be calculated by:

n = 25 years*12months = 300

Effective monthly rate:

In order to get the effective monthly rate, we have to use the formula for the effective annual rate (EAR), which for our case looks at follows:
0.04
( 1+r )6=1+ =¿ r=0.00330589
2

As the actual mortgage is $480,000 and will be re-paid over a period of 300 payments.

Using the Excel formula =pmt(rate,nper,pv,fv), we get the monthly payment of : $2,524.90.

2) Monthly opportunity cost of funds invested

Future value of investment:140,000 ×(1+ 0.00330589)300 =376,822.30

Taking this result gives us the opportunity cost over 25 years by subtracting $140,000 from $376,822.30, which equals $236,822.30.

To calculate the monthly opportunity cost we use the following excel formula: =pmt(rate,nper,pv,fv), Resulting in $462.82

Refer excel sheet for further working.

 Case Study 1 - Group 2
3) Monthly payment Buy vs. rent
Rent:

Monthly rent: -$3,000

+
Monthly opportunity cost $462.82
=
Monthly expenditures: -$2,537.18

Buy:
Monthly mortgage payment: -$2,524.90
+
Monthly condo fee: -$1,050
+
Monthly property tax: -$300
+
Monthly Maintenance: -$50
=
Monthly expenditures: -$3,929.90

Facing the buy vs. rent decision the monthly difference is -$1392.72.

4) Outstanding Principal
Calculating the FV in Excel:
=FV(rate,nper,pmt,pv)

a) After two years

Rate= .00330589
nper (number f periods)= 24
Pmt= 2,524.90
PV= -480.000

Resulting in a outstanding principal of $456,609.29

b) After five years
Rate= .00330589
nper (number f periods)= 60
Pmt= 2,524.90
PV= -480.000

Refer excel sheet for further working.

Resulting in a outstanding principal of $417,858.79

 Case Study 1 - Group 2

c) After ten years

Rate= .00330589
nper (number f periods)= 120
Pmt= 2,524.90
PV= -480.000

Resulting in a outstanding principal of $342,109.0

5) Determine the “net” future gain or loss

Table 5.1

These values indicates the difference between the loss in

Case Study 1 - Group 2

Q6 As Rebecca Young, what decision would you make? Describe any qualitative considerations that could factor into your decision.

Looking at the above projections Rebecca’s best option would be to rent. As seen above the net loss for buying is greater than that of renting. Other qualitative factors that contribute to this decision are;
Buy
 Satisfaction of owning something            
 Do not have to worry about landlord
 Asset that holds value with time

Rent
 Less Stress since property damages don’t affect the renter
 Can move location with little hassle
 less financial burden

Despite the qualitative factors addressed above Rebecca’s best decision would be to choose renting over buying simply because of the clear advantage of both the qualitative and quantitative benefits of renting.

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