8.5. Kathy St Andrews is planning to buy a house for $140,000 by borrowing money

Question

8.5. Kathy St Andrews is planning to buy a house for $140,000 by borrowing money at the rate of 9%. She expects to rent the house for 6 years, collecting $11,000 annual rent in advance each year. She thinks that she can sell the house for $180,000 after 6 years. Kathy has income tax rate of 30%. She will have to pay $3,500 annually in maintenance and real estate taxes, and she will depreciate the house on a straight-line basis for 25 years. The risk-adjusted discount rate in this project is 12%. If all the expenses are fully deductible, and all gains are taxable, should she undertake this project?

ANSWER: NPV = $26,073.70, no ; PLEASE SHOW SOLUTIONS

Explanation / Answer

one time cash flow Purchase price (140,000) Sale value     180,000 Present value factor        0.5066 Present value of inflow        91,188 Net cash inflow     (48,812) Regular cashflow Annual rent        11,000 interest on loan     (12,600) Maitenance        (3,500) Depreciation -        (5,100) Tax benfit          1,530 Presert value of annuity factor     4.60480 (3.6048+1)          7,045 Net present value     (41,767) (48812-7045) Note: depreciation is nil as sale value is more than purchase price

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