Time Value of Money: Buy v/s

Rent Decision

REBECCA YOUNG CASE

 Situation

Rebecca Young, a fresh MBA graduate is faced with a

dilemma of whether to buy or continue to stay in a
rented two bedroom apartment after moving to
Toronto.
She wants to take a decision based on both
qualitative and quantitative factors such as
comparing both the rent and buy decision based on
time value of money (concepts which she learnt in
MBA ).
 Financial Details
Scenario 1: Buy

Price = $600,000
Down payment = 20% of $600,000 $ 120,000
Remaining Payment to be made = $480,000
Other One time payments :
Local deed transfer = 1.5%
Provincial deed transfer = 1.5%
Closing fees = $2000

Total one time payment/lumpsum payment= down payment +

one time charges +Closing fees
=20+1.5+1.5 = 23% of 600,000 = 138,000+2000= $140,000

We will look at the calculations now.

 Calculation

Now to raise the remaining amount ie $480000,

Rebecca plans to take a loan as per below details:

PV = $480,000
Repayment is to be done in 25 years with EMIs
k= 4% pa
n=25 years *12 = 300

First we will need to calculate effective monthly rate to

find out the EMIs.
K=4%pa
Effective monthly rate = (1+k/m)^m 1
= (1+0.04/12)^1/12 -1
= 0.0033
=0.33 %

Now PV = 480000
N=300 , k= 0.0033
Using Formula
PV= A[(1+k)^n -1]/k(1+k)^n
A= 2524
Lets prepare Loan Amortization schedule.

Microsoft Office
Excel Worksheet
FV of loan = 2524*300 =$757,200
Lumpsum( $ 140,000) paid by Rebecca is currently
invested in earning 0.33% monthly rate interested for a
period of 25 yrs or 300 months

FV= PV(1+k)^n
=140,000 (1+0.0033)^300
= 376,159.2

Therefore total FV in case of buy decision =

1,133,359.2
 Scenario 1 : Rent

If Rebecca decides to rent the condo

Monthly rent = $3000

FV of condo if assuming she had invested the amount
for 25 years at 0.33% monthly rate
FV= A [(1+k)^n 1]/k
= 3000[(1+0.0033)^300 1] /0.0033
= $1,533,501
 Conclusion

Therefore from previous slides , its clear that

Rebecca should buy the condo as it is cheaper.
 Purchasing the condominium

Monthly Rent = $1055

Property Tax = $300
Repairs and maintenance = $600 per year
=600/12 = $50 per month
Therefore total monthly effective rent = 1055+300+50
=$1405

P
 Possible Scenarios

Case 1 : condo price remains unchanged

Selling Price = 600000

Realtor Fees = 5% of 600,000+2000
=320,000
Case 2 : condo price drops 10% over the next 2 years,
then increases back to its purchase price by the end
of 5 years, then increases by a total of 10% from the
original purchase price by the end of 10 years

Lets take a look at the board !

Case 3 : condo price increases annually by the annual
rate of inflation of 2% pa over the next 10 years

Lets take a look at the board !

Case 4 : condo price increases annually by an annual
rate of 5%pa over the next 10 years

Lets take a look at the board !