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Time Value of Money The Buy Versus Rent Decision Case Solution

Solution Id Length Case Author Case Publisher
2654 1705 Words (7 Pages) Sean Cleary, Stephen R. Foerster Ivey Publishing : W14403
This solution includes: A Word File A Word File and An Excel File An Excel File

Rebecca Young is attempting to determine the best alternative between renting and purchasing a home. Many aspects must be considered, including additional monthly payments, initial payments, the opportunity cost of buying, property value prediction, and mortgage rate. She recognized that both sides made valid points, but she wanted to examine the buy-versus-rent issue quantitatively in order to offer context for the qualitative aspects that would eventually play a significant role in her decision. Young would spend $1,055 per month in condo fees plus $300 per month in property taxes if she acquired the new condominium. If she leased, she would have to incur costs for repairs and wear and tear maintenance, which she figured would cost $600 per year. If Young chooses to buy the new apartment, she planned to put down 20% of the purchase price in cash. There was also a 1.5 percent municipal deed-transfer tax and a 1.5 percent provincial deed-transfer tax, both of which were due on the acquisition day. 

Following questions are answered in this case study solution:

  1. What is the best solution to take --- to rent or to buy?

  2. What are the assumptions you use?

  3. Calculate the best route for the graduate’s housing situation, developing your understanding of the time value of money (TVM) concepts and calculations.

  4. Describe your assumptions, methodology, and results in your discussion narrative, and attach a simple spreadsheet supporting your analysis.


Case Study Questions Answers

1. What is the best solution to take --- to rent or to buy?

Based on the forecasts above, Rebecca's best choice is to rent. As previously stated, the net loss for purchasing is greater than the net loss for renting. Other qualitative factors influencing this decision include: 

Renting Benefits:
  • Less stress because property damage does not affect the tenant 

  • Ability to relocate with little difficulty

  • Lower financial load

Buying Benefits: 
  • The satisfaction of owning something 

  • Not having to deal with landlords 

  • An asset that appreciates with time Rent 

  • Less Stress since property damage does not affect the tenant

Regardless of the qualitative arguments described above, Rebecca's best option based on quantitative financial reasoning would be to rent the property rather than buy it. The total cost per month for buying would come to be $3,670, and that includes payment for the mortgage, the condo fee per month, property taxes, maintenance costs, and lastly, the opportunity cost. The opportunity cost is the cost of lost opportunity that she may have gotten if she didn’t tie her cash into buying the house. Contrarily, the cost per month for renting a house is $3,000, which is 670 USD less than the cost of buying the house. The excel worksheet attached shows all the calculations for this. In yearly terms, Rebecca could save $8,040 dollars if she would go for renting over buying. All in all, Rebecca should rent the house not just because of quantitative financial reasoning, but also for the fact that doing it won’t tie up her cash, she won't have to worry about maintenance and property taxes, and most importantly, she can move to any location anytime without worrying about sale/purchase of that property.  

2. What are the assumptions you use?

In order to evaluate the case, several assumptions must be examined. The rent growth rate (rental price inflation) was not addressed in our estimate, and we assumed that all connected charges such as condo fees, repair costs, and taxes remained constant, avoiding the general inflation rate for expenses. The whole initial investment is estimated to be $140,000. We assumed she received the monthly interest from the investment account and did not compound the interest to ascertain the variations in her monthly payments on a fixed rate and not a fluctuating rate linked to any benchmark as it does in a real-life scenario. We did not take into account rental price inflation even though, on average, the prices of rental income increase over time because of inflation. We have also not included the expected appreciation of property fair value even though it is very common for property prices to fluctuate cyclically throughout a decade. Since doing that would require forecasting or predicting the economy, we excluded that part and assumed that the fair value of the property would remain stable over the course of the next few years. Furthermore, we assumed that the bank does not impose a prepayment penalty when the loan is closed, even though in real life scenario, the banks would certainly charge extra for the amount of delayed payment. Finally, we assumed she saves $3,000 from various sources of income for home costs (rent or buy). As a result, when computing future gains or losses, we merely consider the increased monthly payment.

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