Question

Sally will be enrolling in a PhD program that is expected to last for five years. With regard to her housing, she is provided with the following two options.

Option #1

Rent a one-bedroom apartment for five years at $1,000 per month.

Option #2

Buy a one-bedroom apartment valued at $500,000. Sally can make a down payment of $100,000, and she will pay $5,000 per month to cover both the mortgage and other homeowner expenses. Note that 10% of these $5,000 monthly payments represent interest payments on the mortgage. Sally intends to sell the apartment once her PhD is over in five years, when the value of the apartment is expected to be $600,000. Sally will be making the monthly payments of $5,000 for the whole time that she owns the apartment.

Assuming that both apartments are located in equally good neighborhoods and equally good buildings, which of these two options is better for Sally? Explain why.

Note: This is not an accounting class, so complex work with a spreadsheet is NOT necessary. Instead, use the information provided to generally explain which option is better for Sally.

Answer 1

1. Outflow in case of Option #1 = Monthly Rent * Number of Years * Months = $1000 * 12 * 5 = $60000

2. Outflow in case of Option #2 = Down Payment + Monthly Payment * Number of Years * Months - Sale Value

Outflow in case of Option #2 = 100000 + 5000 * 5 * 12 - 600000

Outflow in case of Option #2 = -$200000

Buying the house will result in Cash inflow of $200000 while renting housing will result in Cash outflow of $60000

Thus Option #2 is better as it will result in positive cash flow\

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