Question

You can buy a car that is advertised for $24,000 on the following terms: (a) pay $24,000 and receive a $1,000 rebate from the manufacturer; or (b) pay $500 a month for 48 months. Which is the better deal if the interest rate is 12 percent per year and why?

Answer 1

Option 1: pay immediately and avail $1000 rebate:

Present Value of amount paid = $24,000 - $1,000 = $23,000

Option 2: pay $500 for 48 months:

Interest rate (I) = 12%p.a. = 1% p.m.

Monthly payment amount (PMT) = $500

No of months to be paid (N) = 48

Present value of amount paid (PV) = ??

Therefore using financial calculator or PV function in excel,

Present value of amount paid (PV) = 18,987

Therefore it is better to pay $ 500 a month for 48 months instead of paying upfront, since PV of amount paid in 48 months is less than the PV of amount paid immediately.