1. Karou is considering different options for financing the $12,000 balance on her planned new car purchase. The cheapest advertised rate among the local banks is 7 percent for a 48-month car loan. The current rate on her revolving home equity line is 8 percent. Karou is in the 25 percent federal tax bracket and 5 percent state tax bracket and she uses itemized deduction for her tax return. Which loan offers lower monthly payment? Which loan has the lower after-tax cost? Which loan should she choose?
2. Shirley, a recent college graduate, excitedly described to her old sister the $4,500 sofa, chair, and tables she found today. However, when asked she could not tell her sister which interest calculation method was to be used on her credit-based purchase. Calculate the monthly payment and total cost for a bank loan assuming a 1-year repayment period and 12 percent simple interest. Now assume the store uses the add-on method of interest calculation. Calculate the monthly payment and total cost with a 1-year repayment period and 10 percent interest. Explain why the bank payment and total cost are lower even though the stated interest rate is higher.
3. Antonio would like to replace his golf clubs with a custom measured set. A local sporting goods megastore is advertising custom club for $1600, including a new bag. In-store financing is available at 2 percent or he can choose not to renew his $1600 certificate of deposit (CD), which just matured. The advertised CD renewal rate is 3 percent. Antonio knows the in-store financing costs would not affect his taxes, but he knows he’ll pay taxes (25 percent federal taxes and 5 percent state taxes) on the CD interest earnings. Should he cash the CD or use the in-store financing? Why?
4. Noel and Herman need to replace Noel’s car. But with the furniture and appliance payments, the credit card bills, and Herman’s car payment, they are uncertain if they can afford another payment. The auto –financing representative has asked, “What size payments are you thinking of?” Current payment total $475 of their $3250 combined monthly take-home pay. Calculate the debt safety ratio to help them decide about the car purchase and answer the question, “what size payments are you thinking of?” by first assume a 15 percent debt safety ratio and then “stretching” it to a 20 percent.