W14403 TIME VALUE OF MONEY: THE BUY VERSUS RENT DECISION Sean Cleary and Stephan

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W14403 TIME VALUE OF MONEY: THE BUY VERSUS RENT DECISION Sean Cleary and Stephan Foerster mustrate either effective or inemotve wrote this caso soloty ao provide material dass discussion Te authors do not intend to handling of a managerial situation. The authors may have disguised certain names and other case sololy dentifying information to protect confidentiality may not be transmited, photocopied, digitized or otherwise reproduced in any form or by any means without the or the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or Universty, London, Ontario, Caneda, NSG ONT: ( request pemmission to reproduce materials, contact ivey Publishing, Ivey Business Schoot, Westem 519.661.3208 (e) cases@ivey.ca: www.iveycases.com Caeynghr O 2014, Rohardlvey School of Busness Fondation Version: 2015-06-05 In May 2013, Rebecca Young completed her MBA and moved to Toronto for a new job in investment banking. There, she rented a spacious, two-bedroom condominium for $3,000 per month, which included parking but not utilities or cable television. In July 2014, the virtually identical unit next door became available for sale with an asking price of $620,000, and Young believed she could purchase it for S600,000. She realized she was facing the classic buy-versus-rent decision. It was time for her to apply some of the analytical tools she had acquired in business school including "time value of money concepts-to her personal life. While Young really liked the condominium unit she was renting, as well as the condominium building itself, she felt that it would be inadequate for her long-term needs, as she planned to move to a house or even to a larger penthouse condominium within five to 10 years -even sooner if her job continued to work out well. Friends and family had given Young a variety of mixed opinions concerning the buy-versus-rent debate, ranging from "you're throwing your money away on rent" to "it's better to keep things as cheap and flexible as possible until you are ready to settle in for good." She realized that both sides presented good arguments, but she wanted to analyze the buy-versus-rent decision from a quantitative point of view in order to provide some context for the qualitative considerations that would ultimately be a major part of her decision. FINANCIAL DETAILS If Young purchased the new condominium, she would pay monthly condo fees of $1,055 per month, plus property taxes of $300 per month on the unit. Unlike when renting, she would also be responsible for epairs and general maintenance, which she estimated would average $600 per year. f she decided to purchase the new unit, Young intended to provide a cash down payment of 20 per cent of the purchase price. There was also a local deed-transfer tax of approximately 1.5 per cent of the urchase price, and a provincial deed-transfer tax of 1.5 per cent, both due on the purchase date. (For

Explanation / Answer

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1. All groups:

1.a. Monthly Mortgage payments

Equated Monthly Installments (EMI):

EMI = PMT(rate, nper, pv)

= PMT(0.04/12, 25*12, 600000)

EMI = $3167.02

Which is only slightly more than her rent of $3000

Hence it looks attractive at the beginning

1.b. Opportunity cost

Lumpsum = down payment + closing cost

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OppCo = Opportunity cost, Calc = Calculations sqrt = square root, EMI = Equated Monthly Installements condom = condomnium, Q = Question, A= Answer Rent Input data: Rent per month $3,000.00 Bond/deposit(Refundable) Broker commission rate Gross Income per annum Tax % Interest loss compromised on the bond amount costs involved in exiting Buy option input data: Size of the Condomnium Rate $ per sq ft Interest oss compromised on the down payment Broker commission rate Registration fee Stamp duty Cost to maintain $ per sqft Asking price 620,000 can purchase for (Negotiable) $600,000 Tax for the condomnium per month $300.00 Monthly fees $1,055.00 Annual mean (average) repair maintain cost $600.00 Down paymnet 20% = 0.2 * 600,000 $120,000 Local deed transfer tax 1.5% = 0.015 * 600,000 $9,000.00 Provincial tax 1.5% $9,000.00 closing fees (flat?) $2,000.00 External Finance needed for 80% of 600000 $480,000 Part 1.a of 1. All groups of the Q Mortgage deals: 4% fixed rate EMI ($3,167.02) Part 1.b. lumpsum $122,000 4% interest on lumpsum = opportunity cost per year = $4,880.00 OppCo per month = OppCo per year % 12 = 4880/12 $406.67 Part 1.c. External Financing need (EFN) per month to buy the condom Rent was $3000 per month EMI - rent = 3167-3000 = 167.02 plus the Opp Co of $406.67: 167.02+406.67 $573.69 Hence EFN per month to buy it $573.69 So, she will have to pay $3573.69 instead of just $3000 per month

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