8. Alice can get a one-year loan at 5% at her bank, while no bank is willing to

Question

8. Alice can get a one-year loan at 5% at her bank, while no bank is willing to give Brad a one-year loan for less than 10%. Brad has just had surgery, and must pay the hospital $10,000 immediately, but he has no money today, though he will have money in one year. So Alice offers Brad a proposal: she will borrow $10,000 from her bank for one year on her own account, and Brad will repay this loan. In addition, he will pay Alice a sum of money today. What is the maximum amount that Brad should be willing to pay Alice up-front under this arrangement? Alice is not willing to consider borrowing more than $10,000. (2pts)

(a) $454.54 (b) $377.18 (c) $476.19 (d) $500

Explanation / Answer

Value of loan $10,000

Applicable rate of interest for Brad 10%

Applicable rate of interest for Alice 5%

Interest on loan of $10,000 payable by Alice to Bank = $ 10,000 X 5% = $500

Present value of $ 500 @ 10% = $ 454.54

Alice must pay an upfront amount of $ 454.54 option (a) which is present value of interest payable at year end at 10% interest rate on loan of $10,000.

Related Questions

Navigate

• Browse (All)
• Browse 8
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.