Question

Five years ago, firm sj purchased land for $100,000 with $10,000 of its own funds and $90,000 borrowed from a commercial bank. the bank holds a recourse mortgage on the land. for each of the following independent transactions, compute sj’s positive or negative cash flow. assume that sj is solvent, any recognized loss is fully deductible, and sj’s marginal tax rate is 21 percent. required: sj sells the land for $33,000 cash and the buyer’s assumption of the $80,000 principal balance of the mortgage. sj sells the land for $113,000 cash and pays off the $80,000 principal balance of the mortgage. sj sells the land for $82,000 cash and pays off the $80,000 principal balance of the mortgage. sj defaults on the $80,000 mortgage. the bank forecloses and sells the land at public auction for $64,000. the bank notifies sj that it will not pursue collection of the $16,000 remaining debt. sj defaults on the $80,000 mortgage. the bank forecloses and sells the land at public auction for $64,000. the bank requires sj to pay off the $16,000 remaining debt.

Answer 1

• SJ's cash flow is -$27,000 from the sale of the land for $33,000 cash with the assumption of the $80,000 Mortgage.
• SJ's cash flow is $12,320 from the sale of the land for $113,000 cash, paying off the $80,000 mortgage.

• SJ's cash flow is -$18,000 from the sale of the land for $82,000 cash, paying off the $80,000 mortgage.

• SJ's cash flow is -$16,800 due to defaulting on the $80,000 mortgage, with the bank forgiving the $16,000 remaining debt.

Step-by-step explanation:

In the first scenario, SJ incurs a negative cash flow of $27,000 as the sale price of $33,000 is less than the mortgage balance assumed by the buyer.

For the second scenario, SJ experiences a positive cash flow of $12,320. This is calculated by subtracting the original investment ($100,000) and the tax shield on the recognized loss ($5,040, computed as 21% of the recognized loss) from the cash proceeds of $113,000.

In the third scenario, SJ faces a negative cash flow of -$18,000 as the sale price of $82,000 is insufficient to cover the mortgage balance.

In the fourth scenario, SJ undergoes a negative cash flow of -$16,800 due to defaulting on the mortgage. The forgiven debt is not taxable income, but the tax shield on the recognized loss is considered.

Understanding SJ's cash flow in each scenario is crucial for assessing the financial implications of land transactions, factoring in tax considerations and potential losses.