Question

1. An investor has $50,000 in a bank account at a 7% interest compounded annually. She can use this sum to pay for the purchase of a plot of land. She expects that in 10 years she will be able to sell the land for $130,000. During that period she will have to pay $2,000 a year in property taxes and insurance. Should she make the purchase? Base your decision on a rate of return analysis and verify your conclusion with Net Future Value analysis.

Answer 1

Amount Investor have = $50,000

Interest rate investor could have earned = 7%

If she keep her money in bank account, she will have 50,000 * (1 + 0.07)^¹⁰ = 98,357.57 at the end of 10 years

If she invest this amount in land and sell the land for $130,000 after 10 years or net selling price of $128,000 (selling price - tax and insurance cost), rate of return would be

128,000 = 50,000 * (1 + r)^¹⁰

r = 0.0985 which is 9.85% per year

As the rate of return is more than interest rate that could have been earned, she should invest in land.

As I have already calculated, net future value of money invested in bank is also less than the selling price of land, she should invest in land.