# Homework #6: Buy with Cash or finance a purchase

ImieeCooksey1Copyofws_07.2-BorroworPayCash.xls

## ws_07.2

BUY ON TIME OR PAY CASH | |||||||||||||||

Name | Date | ||||||||||||||

Cost of Borrowing | |||||||||||||||

1. | Terms of the loan | ||||||||||||||

a. Amount of the loan | |||||||||||||||

b. Length of the loan (in years) | |||||||||||||||

c. Monthly payment | |||||||||||||||

2. | Total loan payments made | ||||||||||||||

(monthly loan payment × length of loan in months) | |||||||||||||||

$ - 0 | per month × | 0 | months | $ - 0 | YES | ||||||||||

NO | |||||||||||||||

3. | Less: Principal amount of the loan | $ - 0 | |||||||||||||

4. | Total interest paid over life of loan | ||||||||||||||

(line 2 — 3) | $ - 0 | 10% | |||||||||||||

15% | |||||||||||||||

5. | Tax considerations: | 25% | |||||||||||||

• Is this a home equity loan (where interest expenses can | 28% | ||||||||||||||

be deducted from taxes)? . . . . . . . . . . . . . . . . . . . . . . . | 33% | ||||||||||||||

• Do you itemize deductions on your federal tax returns?. | 35% | ||||||||||||||

• If you answered yes to BOTH questions, then proceed | |||||||||||||||

to line 6; if you answered no to either one or both of | |||||||||||||||

the questions, then proceed to line 8 and use line 4 as | |||||||||||||||

the after-tax interest cost of the loan. | |||||||||||||||

6. | What federal tax bracket are you in? | ||||||||||||||

(use either 10, 15, 25, 28, 33, or 35%) | |||||||||||||||

7. | Taxes saved due to interest deductions | ||||||||||||||

(line 4 × tax rate, from line 6: | $ - 0 | × | 0% | $ - 0 | |||||||||||

8. | Total after-tax interest cost on the loan (line 4 - line 7) | $ - 0 | |||||||||||||

Cost of Paying Cash | |||||||||||||||

9. | Annual interest earned on savings (annual rate of interest earned | ||||||||||||||

on savings × amount of loan: | % × | $ - 0 | $ - 0 | ||||||||||||

10. | Annual after-tax interest earnings (line 9 × [1 - tax rate] | ||||||||||||||

— e.g., 1 - 28% = 72%: | $ - 0 | × | %) | $ - 0 | |||||||||||

11. | Total after-tax interest earnings over life of loan | ||||||||||||||

(line 10 × line 1b: | $ - 0 | × | 0 | years) | $ - 0 | ||||||||||

Net Cost of Borrowing | |||||||||||||||

12. | Difference in cost of borrowing vs. cost of paying cash | ||||||||||||||

(line 8 minus line 11) | $ - 0 | ||||||||||||||

BASIC DECISION RULE: | Pay cash if line 12 is positive; borrow the money if line 12 is negative. | ||||||||||||||

Note: For simplicity, compounding is ignored in calculating both the cost of interest and interest earnings. |