a. A rich aunt is going to leave you $145,200 in exactly two years, but now you

Question

a. A rich aunt is going to leave you $145,200 in exactly two years, but now you are broke (or more exactly, you need the money for tuition). If the interest rate is 10%, how much can you borrow now, based on your ability to repay in two years?

b. The list price of a car you want to buy is $16,000. Sales representative A offers it to you for $15,200. Salesperson B won't reduce the price, but will let you pay in a year. From whom should you buy the car

i. if the interest rate is 10%?

ii. if the interest rate is 4%? Explain why, and show any calculations.

Explanation / Answer

Amount due in two years = P * (1+0.10)2 = 145,200

As the maximum amount we can pay after two years is 145,200

Now P = 145200 / 1.12 = 120,000

b.)

PV of future payment = 16,000 / ( 1 + 0.10) = 14545.4

This can be explained that if we deposit 14545.4 in bank today and receive an interest of 10%, we will have 16,000 next year which we can use to pay to B. Hence we will better off with B as we have to pay lesser today

If Interest Payment is 4%

PV = 16,000 / (1 + 0.04) = 15,384.6

Now we are better off with A

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