Suppose you can buy a house for $300,000. You would finance 90% of the purchase

Question

Suppose you can buy a house for $300,000. You would finance 90% of the purchase with an interest only loan priced at 5.5%. Alternatively you could rent an identical house for only $1300/month. Marginal costs of owning home include annual cost of: Property Taxes = 2400, Insurance = 1200, Maint. = 1400, Homeowners association = 600. Your tax rate is 25%. You expect the property to appreciate at an annual rate of 2%. you will hire an agent when you decide to sell the house; sales commission rate is 7% of sales price.

A) Calculate the annual cash flow from owning the house.

B) Calculate the net cash flow from selling the house at the end of the 4th year.

Explanation / Answer

a) According to the given information, Total cash outflows by owning the house are Interest expense = 5.5% ($270,000) {Since 90% of the purchase price is $270,000}                          = $14,850 Property taxes = $2400 Insurance = $1200 Maintenance = $1400 Home association = $600 Total cash outflows = $14,850 + $2400 + $1200 + $1400 + $600                               = $20,450 Therefore, the total cash outflows are $20,450 Total cash inflows by owning the house are Total cash inflows = 2% ($300,000)                             = $6,000 Total cash flows from Owning the house are CAsh inflows = $6,000 Cash outflows = $20,450 b) Calculating the net cash flows from selling the house Total cash outflows Interest expense = 5.5% ($270,000) {Since 90% of the purchase price is $270,000}                          = $14,850 Property taxes = $2400 Insurance = $1200 Maintenance = $1400 Home association = $600 Sales commission = 7% ($300,000)                            = $21,000 Total cash outflows =  $14,850 + $2400 + $1200 + $1400 + $600 + $21,000                               = $41,450 Total cash inflows = $6,000 * 4yrs                             = $24,000 Net cash flows = Total cash inflows - Total cash outflows                        = $24,000 - $41,450                        = $17,450 Therefore, the net cash outflows from selling the house are $17,450                               

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