Homework #6: Buy with Cash or finance a purchase

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Copyofws_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.