Question

Derek and Meagan Jacoby recently graduated from State University and Derek accepted a job in business consulting while Meagan accepted a job in computer programming. Meagan inherited $48,000 from her grandfather who recently passed away. The couple is debating whether they should buy or rent a home. They located a rental home that meets their needs. The monthly rent is $2,750. They also found a three-bedroom home that would cost $208,000 to purchase. The Jacobys could use Meagan’s inheritance for a down payment on the home. Thus, they would need to borrow $160,000 to acquire the home. They have the option of paying two discount points to receive a fixed interest rate of 4.50 percent on the loan or paying no points and receiving a fixed interest rate of 5.75 percent for a 30-year fixed loan.

Though anything could happen, the couple expects to live in the home for no more than five years before relocating to a different region of the country. Derek and Meagan don’t have any school-related debt, so they will save the $48,000 if they don’t purchase a home. Also, consider the following information:

• The couple’s marginal tax rate is 24 percent.
• Regardless of whether they buy or rent, the couple will itemize their deductions.
• If they buy, the Jacobys would purchase and move into the home on January 1, 2018.
• If they buy the home, the property taxes for the year are $4,100.
• Disregard loan-related fees not mentioned above.
• If the couple does not buy a home, they will put their money into their savings account where they earn 5 percent annual interest.
• Assume that all unstated costs are equal between the buy and rent option.

Required: Help the Jacobys with their decisions by answering the following questions: (Leave no answer blank. Enter zero if applicable.)

a. If the Jacobys decide to rent the home, what is their after-tax cost of the rental for the first year (include income from the savings account in your analysis)? (Round your intermediate calculations to the nearest whole dollar amount.)

Answer 1

Calculate the total rent paid for one year as follows: Total rent =Monthly rentx12 months =$2750x12 = $33,000 Calculate Interest eamed on Inheritence as follows: Interest = Inherited amount Fixed interest rate = $48.000x 5.75% =$2760 Calculate the after-tax cost of the rental for the first year as follows: Amount ($33.000) Particulars Total rent paid Interest earned on inheritance amount Tax on interest earning ($2760*24%) $2,760 ($662) $2.098 Total after-tax cost of rent for the first year ($30.902)