Question

Last year, you graduated from University with a diploma in Business Management and were able to get a full-time job immediately after graduation. After working for one year, you have $10,000 of savings! This happens to be the same amount that is outstanding on your student loan, so you are thinking about paying off your student loan fully. However, you are also considering a few other options for either spending or investing your savings. First, you think that it might be worthwhile to just invest the $10,000 in the stock market, rather than paying off the student loan. However, your friend just asked you to join her on a three month trip around Europe and you would really like to go. You have six weeks of vacation that you could use towards this trip (from last year plus this upcoming year) and your work agreed to let you take the remaining time off unpaid. You expect the trip to cost about $10,000. Since you took a few finance classes at , you are going to calculate what your financial position will be in one year under each option and then make a decision about what to do.

You’ve gathered the following information to help you make a decision:

• Your starting savings is $10,000 and debt (student loan) is $10,000.

• You are paying interest on your student loan of prime + 2.5% (assume the prime rate is 3.7%).

• You are fairly confident that you could earn an 8% return on your stock investments next year.

• If you go to Europe you will have to take six weeks of unpaid time off work. You earn $5,500 in six weeks. However, you will rent out your apartment for the three months that you are away and you won’t have to spend money on your typical expenses, such as food and transportation (these are already budgeted into your $10,000 trip cost). You expect to save $3,000 in regular expenses while you are Europe.

1. For each option, list your total savings, total debt, and savings minus debt in one year. For simplicity, ignore all other financial transactions, such as additional savings, additional debt, and monthly payments on the student loan (see below and attend class for tips on how to calculate these).Include the completed table in your submission, and show your work outside of the table.

Option	Total Savings	Total Debt	Total Savings Minus Debt
Pay off student loan
Invest in stock market
3 Month trip to Europe

2. What do you choose to do with your savings: pay off student loan, invest in stock market, go to Europe, or a different option? Explain why you chose that option.

Assignment 1 - Some things to keep in mind:

• For the pay off student loan option, you use your savings to pay off the debt.

• For the invest in stock market option, you earn interest on the savings invested and accumulate interest on the student loan. Assume that you pay and earn simple interest at the annual rates shown above.

• For the Europe trip option, add the lost wages minus expense savings to the total cost of the trip and assume that the trip is funded through savings (savings can be negative).

• There is no right or wrong answer for question 2.

• The analysis you did is only for one year, but you may want to consider what the longer term impacts are of each option.

• You can choose an alternative option.

• When you explain why you chose your option, you may want to refer to the other options - why is your selected option better than the other options?

• You may want to consider your risk preferences - keep in mind that the stock market return is not certain; you could earn a much higher rate or a much lower rate.

Answer 1

Total Savings Minus Debt Option Payoff student loan Invest in stock market 180 Total Savings Total Debt 10,000 10000 10800 10620 =10000*1.08 =10000*(1+2.5%+3.7%) -12500 10620 --10000+3000-5500 =10000*(1+2.5%+3.7%) 3 month trip to Europe (23,120) Judging by column E, we'll choose to invest in stock market as this will give us the maximum payoff. However, the answer may vary based on certain assumptions If we are risk averse, we will choose to payoff the student loan, since the return in market is uncertain and could be lower than the debt interest rate If You value life experience more and can payoff the debt later on, you'll choose to go on Europe trip