Capital Budgeting Decisions Exercise (2) Instructor: Dr. Lou Learning Objectives 2. Apply capital budgeting to property investment (a) Develop proforma cash flows for property investment project (b) Compute NPV, IRR (c) Develop Problem-Solving and Critical Thinking Skills 1) buy house in all Cash Or Mortgage; project period =15 years 2) property value 5) Rent-to-Price Ratio 3) down payment $200,000 6) inflation, rental, property value appreciation 10% 4) 10 -yr mortgage at 5.5% 7) sell the property at the end of 15th year 8) annual rental income 3.50% case 1: Investment $50,000 8) annual rental income $20,000 case 1: Investment \begin{tabular}{|c|c|c|c|c|c|c|c|c|c|c|c|c|c|c|c|c|c|} \hline & & & & & & & +2 & & & & & & \begin{tabular}{ll} \\ \end{tabular} & & & & \\ \hline \multicolumn{18}{|c|}{\begin{tabular}{|c|l|l|} NPV= & IRR = & \\ \end{tabular}} \\ \hline inflation & erty valu & tion) & + & +2 & + & + & + & & & & & & & & & & \\ \hlineXXXX & XXXX & 50,000 & 100 & 100 & 100 & 100 & 100 & XXXXX & XXXXX & XXXXX & XXXXX & XXXXX & 20,000 & 20,000 & XXXXX & XXXXX & XXXXX \\ \hline & & & & & & & & & & & & & & & & & \\ \hline \end{tabular} Q\#1 Use IRR to comapare Cash vs Mortgage? With all cash buying, all the return of the property (from rental) is earned and not offsetted by mortgage cost, hence Cash better than Mortgage? Q\#2 At required return 7\%, find NPVs to compare Cash vs Mortgage (mutually exclusive), conclusion consistent with IRR? How about required rate 6%, required rate 5.5%, required rate 5%, etc., discuss your finding. (WITH inflation, rental, property value appreciation) \begin{tabular}{|c|c|c|c|c|c|c|c|c|c|c|c|c|c|c|c|c|} \hline & & 100 & 800 & & xxyxy & xyxyx & xyxyx & & & & & & 20 & & & \\ \hline XXXXX & 200,000 & 20,000 & 20,700 & 21,425 & 22,174 & 22,950 & 23,754 & 24,585 & 25,446 & 26,336 & 27,258 & 28,212 & 29,199 & 30,221 & 31,279 & 367,444 \\ \hline & *growing rental=> & 20,000 & 20,700 & 21,425 & 22,174 & 22,950 & 23,754 & 24,585 & 25,446 & 26,336 & 27,258 & 28,212 & 29,199 & 30,221 & 31,279 & 32,374 \\ \hline \end{tabular}