Reference no: EM132566578

Emily and Joel Schumaker are married clients who have just been approved for a twenty-year, $150,000 mortgage. They have been given a choice of two loans. One loan has an annual percentage rate (APR) of 8 percent and does not carry a fee, and the other has an APR of 7.5 percent but carries a discount fee of 2 percent of the initial loan amount. The fee for the second mortgage is payable in cash at loan inception and cannot be financed with the loan.

Question 1: From a present value cost perspective, which loan is the better deal, assuming (a) they sell their home immediately after making ten years' worth of payments and (b) they require a 9 percent effective annual rate of return? Stated another way, which option has the lower cost?

When conducting the analysis, assume all required payments are made at the end of each month and that interest is compounded monthly. Remember to consider the difference in loan payment, the difference in remaining balance at the time of sale, and the present value of the discount points on an after-tax basis assuming the points are fully deductible. For the purposes of this question, assume the clients are in a marginal 25 percent tax bracket. (Hint: You can solve this problem at either T0 or T120.)