3. Suppose you want to buy a car for college. Your awesome uncle is willing to s

Question

3. Suppose you want to buy a car for college. Your awesome uncle is willing to sell you his $20,000 car which he no longer needs. He will only charge you 1% interest per year on the value of the car. Also, since he knows that you will be cash strapped for your 4 years j college, he will only require that you start paying him a year after you graduate. Draw timelines and show your work. (a) Assuming 10 equal annual payments, what is the payment amount? (b) What is the payment amount if you instead went to the bank to finance given the same conditions except that the bank charges 6.094 interest? (c) What is the net present value of this car transaction? (Hint: use the bank interest rate to convert your uncle?s offer) (d) Is your aunt or uncle more generous?

Explanation / Answer

a) 10 equal annual payments means = $2000 + $200(1% interest on value of car) = $2200 annually

Payment amount = 2200 * 10 = $22000

b) Since bank is charging more interest it is going to be surely higher payment than what uncle was charging.

c) NPV = 22000/(1.0609)10

d) Yes

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