Question

 Case Questions

 1. What are the cash flows associated with each of Adam's three car financing options? 

 2. Suppose that, similar to his parents, Adam had plenty of cash in the bank so that he could easily afford to pay cash for the car without running into debt now or in the foreseeable future. If his cash earns interest at a 5.4% APR (based on monthly compounding) at the bank, what would be his best purchase option for the car?

 3. In fact, Adam doesn't have sufficient cash to cover all his debts including his (substantial) student loans. The loans have a 10% APR, and any money spent on the car could not be used to pay down the loans. What is the best option for Adam now? (Hint: Note that having an extra $1 today saves Adam roughly $1.10 next year because he can pay down the student loans. So, 10% is Adam's time value of money in this case.)

 4. Suppose instead Adam has a lot of credit card debt, with an 18% APR, and he doubts he will pay off this debt completely before he pays off the car. What is Adam's best option now?

 5. Suppose Jenna's Treasury bond has a coupon interest rate of 6.5%, paid semiannually, while current Treasury bonds with the same maturity date have a yield to maturity of 5.4435% (expressed as an APR with semiannual compounding). If she has just received the bond's 10th coupon, for how much can Jenna sell her treasury bond?

 6. Suppose Jenna sells the bond, reinvests the proceeds, and then saves as she planned. If, indeed, Jenna earns a 9% annual return on her savings, how much could she withdraw each year in retirement? (Assume she begins withdrawing the money from the account in equal amounts at the end of each year once her retirement begins.)

 7. Jenna expects her salary to grow regularly. While there are no guarantees, she believes an increase of 4% a year is reasonable. She plans to save $3000 the first year, and then increase the amount she saves by 4% each year as her salary grows. Unfortunately, prices will also grow due to inflation. Suppose Jenna assumes there will be 3% inflation every year. In retirement, she will need to increase her withdrawals each year to keep up with inflation. In this case, how much can she withdraw at the end of the first year of her retirement? What amount does this correspond to in today's dollars? (Hint: Build a spreadsheet in which you track the amount in her retirement account each year.)

 8. Should Jenna sell her Treasury bond and invest the proceeds in the stock fund? Give at least one reason for and against this plan.

 9. At the last minute, Jenna considers investing in Coca-Cola stock at a price of $55.55 dividend is due in one year, what per share instead. The stock just paid an annual dividend of $1.76 and she expects

 the dividend to grow at 4% annually. If the next expected return is Coca-Cola stock offering?

Answer 1

2. If Adam would have had enough cash like his grad parents, then he would have paid the entire price of car in cash. He will get a rebate of $4000 if he choose for complete cash and will pay $31000 in cash.

As, his saving bank account has a interest rate of 5.4%, he will loose: (31000*( 1 + k/m )^m*n) - 31000

=> (31000*( 1+0.054/1)^1*4) - 31000

=> (31000* (1.054)^4) - 31000

=> 38258.16 - 31000 = $7258.16. This is the amount of interest, he will loose in 4 years.

• If he go for zero percent financing, then he will pay total price of $35000 for car, but he will also loose interest on cash saved in bank account, which is 35000*(1+0.054)^4 -35000 = 43195 - 35000 = $8195. So, the effective cost will be 35000 + 8195 = $43195.
• If he go for rebate with no money down: he will pay $31000 as a loan @8% APR and he will ens up paying 31000*( 1+0.08/1)^1*4 = 42175.16 and he will earn saving interest on 4000 amount got as rebate, which will be (4000*(1+0.08)^4) -4000 =  5442 - 4000 = $1442. Hence, the total effective cost will be 42175.16 - 1442 = $40733.
• If he pays cash, then he will get a rebate of 4000 and he will pay 31000 in cash. The amount of saving account interest, he will loose for 31000 in 4 years will be $7258 and hence the total effectively cost will be 31000 + 7258 = $38258.

Hence, he should purchase the car in cash completely.

3. Now, i think the best option for Adam is to go for a down payment of some amount , say 4000 and then finance the car for the rest for the amount of 31000 for 4 years. This way, he will save cash in hand to pay his student loans. $31000 saved in his first month will become 31000*1.10 after 1 years will become $34100. This will be augmented with monthly savings also along with the earned interest rates.

4. If Adam wants to make sure that credit card loan @18% will be paid along with car loan, then he has to reduce the down payment of the car and see, how much he is savings each month after paying car loan. He needs to check, whether the savings will be good enough to pay credit card loan. I can't comment on the exact amount here, as we don't know the size of credit card loan.