Option 1: Julio Cuevas can by a 4-plex apartment complex in central Laredo. The

Question

Option 1:

Julio Cuevas can by a 4-plex apartment complex in central Laredo. The asking price is $185000. He wants to buy it and sell it in 10 years. Because his credit history is excellent and because he has a big ranch in Zapata, Texas community bank is willing to give him a loan at 7% (15 year mortgage). But he still needs to pay down payment of 20 percent. He plans to rent it out, at $700 per apartment per month. He expects to have no problem finding tenants. He will need to put in about 5000 dollars to fix things at this new place before he starts renting them out. He will be able to do that in week. The closing cost will be 7% of property price, but the seller will cover half of it. The maintenance cost for the 4-plex apartment is 400 per month—a company has agreed to take care of it. The combined value of property tax, school tax, and county tax is 2.5%. Although these taxes are due at the end of the year, they will be collected by his bank every month. Assume that for tax purpose, there was increase in price of the apartment. Julio currently has the money he needs for this investment in his bank. Julio wants do this for 10 years and the sell it. He expects the price of houses to increases by about 1.5% every year for the next 10 years. The closing cost when he sells it will be 7 percent. He will be paying all of the closing cost.

Option 2:

Participate in financial scheme of International Bank of Commerce, where he puts a certain amount of money in the bank. He will get back one twelfth of 6 percentage of much he deposited every month. And get triple of what he deposited at the end of 10 years. (HINT: for the purpose of this calculation, you can put any amount as the initial amount, it will not affect the IRR).

A) What is the IRR for option 1? Also, draw the cash flow diagram that you will use to calculate the IRR? You will get very little credit if the cash flow picture is incorrect.

B) What is the IRR for option 2? Also, draw the cash flow diagram that you will use to calculate the IRR? You will get very little credit if the cash flow picture is incorrect.

C) Based on the IRR calculation that you did, which option appears to be better?

D) Which option is riskier? What is the risk? And, why is it riskier?

Explanation / Answer

WORKINGS Annual Rent = 700*4*12=33600 Annual Maintenance 400*12 = 4800 Annual Cost Appreciatn Original cost Appreciation Annual Appn. 187775 185000 2775 2775 190591.625 185000 5591.625 2816.62 193450.499 185000 8450.499 2858.87 196352.257 185000 11352.26 2901.76 199297.541 185000 14297.54 2945.28 202287.004 185000 17287 2989.46 205321.309 185000 20321.31 3034.31 208401.129 185000 23401.13 3079.82 211527.145 185000 26527.15 3126.02 214700.053 185000 29700.05 3172.91 Appreciated sale value 214700 Monthly annuity payment to bank for tax Total tax =185000*2.5%* 10yrs.= 46250 To calculate the monthly payment to bank 46250=(x*((1-(1+0.00208)^-120)/0.00208)) x=Monthly payment = 435.91 Annual =435.91*12= 5230.92 Annual cash outflow/inflow calculations Year Rent Income Annual appreciaion Maintenance Tax Loan interest Net Cash flow 1 33600 2775 4800 5231 12950 13394 2 33600 2816.62 4800 5231 12950 13435.63 3 33600 2858.87 4800 5231 12950 13477.87 4 33600 2901.76 4800 5231 12950 13520.76 5 33600 2945.28 4800 5231 12950 13564.28 6 33600 2989.46 4800 5231 12950 13608.46 7 33600 3034.31 4800 5231 12950 13653.31 8 33600 3079.82 4800 5231 12950 13698.82 9 33600 3126.02 4800 5231 12950 13745.02 10 33600 3172.91 4800 5231 12950 13791.91 10 th year cash flow Appreciated sale value 185000+29700= 214700 Less;Closing costs 7% *214700 15029 Annual cash inflow (from Table) 13792 213463 Initial Year 0 cost details Purchase price -148000 Down payment -37000 To fix things -5000 Closing cost -6475 -196475 Year 0 Details (Outflow)/Inflow 0 Initial cost -194675 1 Rent-Maint.-tax 13394 2 13435.63 3 13477.87 4 13520.76 5 13564.28 6 13608.46 7 13653.31 8 13698.82 9 13745.02 10 213463 IRR of tis cash flow 7.15%

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