Question

You need a new car and the dealer has offered you a price of $20,000?, with the following payment? options:

(a) pay cash and receive a $2,000 ?rebate, or? (b) pay a $5,000 down payment and finance the rest with 0% APR loan over 30 months. But having just quit your job and started an MBA? program, you are in debt and you expect to be in debt for at least the next 2? ½ years. You plan to use credit cards to pay your? expenses; luckily you have one with a low? (fixed) rate of 13.74% APR. Which payment option is best for? you?

Answer 1

(a) Present value in this case = 20,000 - 2,000 = $18,000. No loan is involved and so presnet value = price of the car - rebate amount.

(b) Here upfront payment = $5,000 and so borrowing = 20,000 - 5,000 = $15,000.

Monthly payment = $15,000/30 months = $500 per month

Now monthly rate = 13.74%/12 = 1.145%

The next step is to compute the present value of this option. This can be done using the "PV" function in excel, The input parameters will be: Rate = 13.74%12 = 0.01145 or 1.145%, Nper = 30 and Pmt = -500 (as it is a cash outflow).

Excel gives us PV value of $12,634.54

Thus total PV of second option = 5,000+12,634.54

= $17,634.54

As PV of option 2<PV of option 1 the 2nd payment option (pay a $5,000 down payment and finance the rest with 0% APR loan over 30 months) is the best for you.