Case Name The Smithson’s Mortgage Case Study Teams This case is designed to be conducted by a team of students. The discussion, questioning, and resolution of differences is an important part of the learning experience. Another significant advantage is the sharing of the workload in preparing the final case study report. Knowledge Background This case draws heavily on the material presented in Chapters 2 and 3 of Principles of Engineering Economic Analysis, 4th Edition by White, Case, Pratt, and Agee, particularly Section 3.4 (Principal Amount and Interest Amount in Loan Payments). To a limited extent it draws on concepts from Chapter 4 (Measuring the Worth of Investments), Chapter 5 (Comparison of Alternatives), and Chapter 6 (Depreciation and Income Tax Considerations. The case can be meaningfully addressed after covering Section 3.4. Deliverables Case Report - one per team (refer to attached page for additional information) Peer Evaluations - every individual (refer to attached page for additional information) Additional Notes to Instructor ( A reasonable amount of time to complete this case is 4-6 weeks. ( The detailed specification of rounding rules in the case is designed to maintain consistency in the responses; otherwise, slight differences in rounding approaches can lead to large differences in final retirement account balances. ( An interesting embellishment to the case is to ask students to examine different objectives for the Smithson’s (e.g., minimizing interest paid rather than maximizing retirement account balance).
The Smithson’s Mortgage
Paul and Leslie Smithson are buying a new house. They have saved for several years to accumulate a down payment and have now found a house that is just perfect for their needs. It is a beautiful three bedroom Tudor house in a quiet neighborhood in the suburbs. With the help of their real estate agent and after several rounds of offering and counter-offering, they have agreed on a price of $103,000 with the sellers. The only thing that remains to make their new home a reality is to select a mortgage. Paul and Leslie are unsure about the details of making this type of decision and have come to you for guidance because of your expertise in this area. Paul and Leslie are both 30 years old and professionally employed. They earn generous salaries and fall into the 28% effective tax bracket on their personal income taxes. They dream long term of retiring at the age of 65 so they can travel the country to take in all its scenic beauty. It is this dream that drives them to determine a mortgage arrangement that allows them to generate the maximum retirement account balance that they can create to supplement their company sponsored retirement plans. They currently have accumulated $10,000 to use for the down payment and closing costs on their house. Any excess amount not used in this way could be used as an initial deposit in their retirement savings account. Alternatively, any excess could be used to make a down payment in excess of the minimum requirement. After studying their budget and spending patterns they have determined that they can afford $1,000/month to cover both mortgage payments and personal retirement savings. They are strongly committed to their retirement travel plans, so any of the $1,000 not spent on the mortgage will be invested in the retirement savings account. In addition, any tax savings generated through the mortgage will be deposited in the retirement account. Although they anticipate salary increases over the years until they retire, the impact of inflation and changes in lifestyle will offset these to the extent that the $1,000 per month can be considered constant over the next 35 years. They have selected a retirement savings vehicle which involves investment in a tax sheltered mutual fund which pays an average of 9% per year compounded monthly. Paul and Leslie, with the help...