Product Overview

This case considers a simple buy-versus-rent decision in the context of an individual family home. In mid-2022, the rise in real estate prices in the Washington, DC, metro area has resulted in a dramatic increase in the rental rates for a young working couple. They must compare paying the higher rent with an opportunity to buy their friends’ house on Ramsay Street. This decision elicits a discounted-cash-flow analysis that serves as an introduction to valuation based on equity residual cash flow. The mortgage financing required with the house purchase invites a discussion of leverage and its effect on the risk of their equity stake as well as the appropriate risk premium to be used in the discount rate. At the Darden School of Business, this case is used in the elective courses “Managerial Finance” and “Valuation in Financial Markets,” as an introduction to equity-residual-cash-flow valuation and financial risk.

Learning Objectives

The case serves to meet any of the following teaching objectives: (1) Explore traditional corporate finance discounted-cash-flow analysis in a personal finance or real estate finance context. (2) Provide a simple introduction to the concept of equity residual cash flow and debt cash flow as students explore mortgage financing and the effect on the equity position. This introduction is intended to build on an existing understanding of free cash flow or total cash flow. (3) Motivate the effects of leverage, financial risk, and the levered beta relation. (4) Review concepts of incremental cash-flow analysis and the identification of value drivers.