Cost of Credit / Opportunity Cost / Trade-Offs
In this scenario you will calculate the monthly payment and total interest paid on a car loan. Suppose that you need $15,000 to buy a used vehicle to get back and forth to work and school. You have $7,500 in a money market fund earning 1.00% per year, but you are not sure you want to use any or all of that money.
Using the tables in Exhibit 1-D, located on pp. 42-43 in the Ch. 1 Appendix of Focus on Personal Finance, determine the total amount of payment due at the end of each year, and divide by 12 to estimate the monthly payment for each of the following loan scenarios. Also, calculate the total amount of interest you would pay over the life of each loan. Be sure to show your work for opportunities to earn partial credit, where applicable.
For example, if you have the correct formula but put a decimal in the wrong spot you could earn partial credit. The first row in the table has been completed to demonstrate you how work can be shown.
| Loan Amount | Interest Rate | Term | Monthly Loan Payment = Amount Borrowed divided by “Table Factor in Exhibit 1-D” divided by 12 | Total Amount of Interest = (Monthly Loan Payment * Term * 12) – Loan Amount |
| $7,500 | 6% | 3 years | Example:
7500/2.673=2,805.84 2,805.84/12= 233.82 |
Example:
(233.82*3*12) – 7,500= 917.52 |
| $7,500 | 6% | 5 years | 7,500/4.329=1,732.50
1,732.50/12=144.38 |
(144.38*5*12)=8,662.80
8,662.80-7,500=1,162.80 |
| $10,000 | 6% | 5 years | 10,000/4.329=2,310.00
2,310.00/12=192.50 |
(192.50*5*12)=11,550.00
11,550.00-10,000=1,550.00 |
| $15,000 | 6% | 5 years | 15,000/4.329=3,465.00
3,465.00/12=288.75 |
(288.75*5*12)=17,325.00
17,325.00-15,000=2325.00 |
6. Based on the above calculations, the price of the car, and the money available in a money market fund, which loan option would you suggest to someone purchasing a vehicle? Please explain the rationale and considerations for your decision.
I would recommend the third loan, $10,000 at 6% over 5 years and use $5000 from the money they have in the money market fund. The person in this example is in school and probably has other expenses so the payment would be low and they would have $2500 left for other expenses from their money market fund. In the end they would pay a little more in interest than the first and second loan but not much more. Ideally, if their personal finances would allow it, loan number one would be great because they would not pay much interest at all but the monthly payment would be much higher than the others.
7. In your own words, how would you summarize “opportunity cost”? How does the concept of opportunity cost apply to this decision? Explain in a brief paragraph.
Opportunity cost is basically weighing out all your options and choosing the best choice at that particular time. The gain lost from making this choice over another option is “opportunity cost”. It could be a gamble in some instance but one must take all factors into consideration. It applies in this decision because the person must choose to either continue saving the $7500 they have invested or use it towards the purchase of a new car. Taking out a loan would let him keep part or all of the money he has invested or he could use it all and pay a smaller loan off faster. It’s a personal decision that one must make with information gathered beforehand.
Income Taxes
Each year you will need to file a federal income tax return by April 15th. While you may use software or a tax preparation professional to help you complete your return, there are still some terms of which you should have a basic understanding. Respond to the following to demonstrate your understanding. Each response should be at least 50 words.
8. Explain the differences between taxable income and adjusted gross income.
<Write response here.>
9. In your own words, define tax deduction, exemption, and tax credit.
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