You have just earned your MBA and have three student loan balances outstanding.

Question

You have just earned your MBA and have three student loan balances outstanding. They all mature in 5 years. The Amounts owed and the associated interest rates are shown in the table below. You can also combine these loans ($64,000) into a consolidated loan from the bank at a rate of 7.2% annual interest for a period of 5 years. Should you consolidate these or stay with the three seperate loans? Hint: Weighted average cost of the three loans vs. the consolidated bank loan @7.2%.

Loan 1--Balance Due: $20,000--Annual interest rate 6%

Loan 2--Balance Due: $12,000--Annual Interest rate 9%

Loan 3--Balance Due: $32,000--Annual Interest rate 5%

MUST SHOW WORK IN EASY TO UNDERSTAND DETAIL

Explanation / Answer

Weighted average cost means the average cost multiplied by the weights, Here the weights are the three different loans. Weighted average cost will be interest on each loan for a year whole divided by the loan.

Weighted average cost of three loans = (($20,000*6%)+($12,000*9%)+($32,000*5%))/ $64,000

Weighted averagecost of three loans = $(1200+1080+1600)/ 64,000

Weighted averagecost of three loans = 6.0625%

This means the average cost of the loans are 6.0625% which is less than the interest rate on the consolidated loan.

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