1. What are the cash flows associated with each of Adam’s three car financing options?
2. Suppose that, similar to his parents, Adam had plenty of cash in the bank so that he could easily afford to pay cash for the car without running into debt now or in the foreseeable future. If his cash earns interest at a 5.4% APR (based on monthly compounding) at the bank, what would be his best purchase option for the car?
3. In fact, Adam doesn’t have sufficient cash to cover all his debts including his (substantial) student loans. The loans have a 10% APR, and any money spent on the car could not be used to pay down the loans. What is the best option for Adam now? (Hint: Note that having an extra $1 today saves Adam roughly $1.10 next year because he can pay down the student loans. So 10% is Adam’s time value of money in this case.)
4. Suppose instead Adam has a lot of credit card debt, with an 18% APR, and he doubts he will pay off this debt completely before he pays off the car. What is Adam’s best option now?
5. Suppose Jenna’s Treasury bond has a coupon interest rate of 6.5% paid semiannually, while current Treasury bonds with the same maturity date have a yield to maturity of 5.4435% (expressed as an APR with semiannual compounding). If she has just received the bond’s tenth coupon, for how much can Jenna sell her treasury bond?
6. Suppose Jenna sells the bond, reinvests the proceeds, and then saves as she planned. If, indeed, Jenna earns a 9% annual return on her savings, how much could she withdraw each year in retirement? (Assume she begins withdrawing the money from the account in equal amounts at the end of each year once her retirement begins.)