Problem:
You are going to begin your freshmen year of college and you will be getting a student loan to help pay for your schooling. You will have four different options that you will need to analyze to answer the questions identified below. The option and the terms of the loans are provided below.
Loan Terms:
- All loans shall be computed at an annual percentage interest rate (APR) of 3.75%
- It is assumed that you will need the loan for four years (eight semesters)
- It is assumed that you will be gainfully employed upon graduation and will begin repaying the principle four calendar years after the loan(s) began
- You will not make any payments towards the principle of the loans while you are attending college
- It has been determined that you will need $48,000 ($6000 a semester) to finish school
Loan Options:
1. You can take the loan in one lump sum of $48000 at the beginning of the four years. Using this option you will also be able reinvest the remainder of the loan into a CD for six months each time; i.e. after paying for the first semester you can invest $42000 and after paying for the second semester you can invest $36000, after the third semester you can invest $30000, etc.... This CD will return an annual percentage interest rate (APR) of 1.25%. For this option you will not be making any payments on the interest (from the loan) generated from the principle while you are attending school, so no payments for four years.
2. You can take the loan in one lump sum of $48000 at the beginning of the four years. Using this option you will also be able reinvest the remainder of the loan into a CD for six months each time; i.e. after paying for the first semester you can invest $42000 and after paying for the second semester you can invest $36000, after the third semester you can invest $30000, etc.... This CD will return an annual percentage interest rate (APR) of 1.25%. For this option you will be making monthly payments on the interest (from the loan) generated from the principle while you are attending school.
3. You can take the $6000 at the beginning of each semester. You will not be given the chance to reinvest anything this time because you will use the principle every semester to pay for school. For this option you will not be making any payments on the interest (from the loan) generated from the principle while you are attending school, so no payments for four years.
4. You can take the $6000 at the beginning of each semester. You will not be given the chance to reinvest anything this time because you will use the principle every semester to pay for school. For this option you will be making monthly payments on the interest (from the loan) generated from the principle while you are attending school.
1. Draw a cash flow diagram for each option
2. For each option you need to have hand calculations that determine the total amount owed and income generated at the end of the four years
3. For each option you need to have hand calculations that determine the annual percentage yield for each option
4. Explain which option is ultimately the most expensive and why you think it is
5. Explain which option is ultimately the least expensive and why you think it is