Reference no: EM132668308

Problem - Investor Loss Limitations Affect the Viability of Certain Investment Opportunities

Trudy and Jim Reswick are considering ways to enhance their financial security. In fact, they are willing to borrow a substantial sum so that they can make an appropriate investment.

Currently, Trudy and Jim's sole sources of income are their salaries, totaling $100,000, from their full-time jobs. Their most significant asset is their personal residence (fair market value of $500,000 with a mortgage of $350,000). The Reswicks' financial planner suggests that they borrow $100,000 at 6 percent and use the proceeds to make one of the following investments:

A high-growth, low-yield portfolio of marketable securities. The portfolio's value is expected to grow 8 percent each year.

An interest in a limited partnership that owns and operates orange groves in Florida. The limited partnership interest is expected to generate tax losses of $25,000 in each of the next five years, after which profits are expected. Their financial planner predicts that after taking into account the tax benefit from the losses, the Reswicks would average an annual 8 percent return over a 10-year period.

An interest in a local limited partnership that owns and rents apartments to college students. This limited partnership interest also would generate losses of $25,000 per year for five years, after which profits would follow. These expected profits and losses would produce an average annual total return of 8 percent over a 10-year period.

Trudy and Jim want to choose the alternative that produces the best after-tax return over a 10-year planning horizon. They are aware, however, that tax restrictions may limit the advantages of some of these investment options. In this connection, evaluate each option.