Question

1.      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.

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	149.39	1,403.13
$10,000	6%	5 years	197.85	1,870.85
$15,000	6%	5 years	296.77	2,806.27

1.      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.

Answer 1

The interest earned on money market funds at 1% on $7500 for 3 years will be : 7500 * (1+1%)³ - 7500 = 227.26

The interest earned on money market funds at 1% on $7500 for 5 years will be : 7500 * (1+1%)⁵ - 7500 = 382.58

Given that the return (interest earned) in the money market fund is significantly lower that the interest that will have to be paid on the loan, it would be prudent to utilise the money market investments for purchasing the car and go with the 3 year $7500 loan option since the cost of borrowing would be lowest in terms of interest to be paid. Note that we have ignored here all other aspects like keeping emergeny funds and are going only by keeping the borrowing costs to the minimum.