P16 5 Borrow or pay cash for an asset Bob and Carol Gibbs are set to move into

Question

P16- 5 Borrow or pay cash for an asset Bob and Carol Gibbs are set to move into

their first apartment. They visited Furniture R’Us, looking for a dining room table and buffet. Dining room sets are typically one of the more expensive home furnishing items, and the store offers financing arrangements to customers. Bob and Carol have the cash to pay for the furniture, but it would definitely deplete their savings, so they want to look at all their options.

The dining room set costs $3,000, and Furniture R’Us offers a financing plan that would allow them to either (1) put 10% down and finance the balance at 4% annual interest over 24 months or (2) receive an immediate $200 cash rebate, thereby paying only $2,800 cash to buy the furniture.

Bob and Carol currently earn 5.2% annual interest on their savings.

a.Calculate the cash down payment for the loan.

b.Calculate the monthly payment on the available loan. (Hint: Treat the current loan as an annuity and solve for the monthly payment.)

c.Calculate the initial cash outlay under the cash purchase option.

d.Assuming that they can earn a simple interest rate of 5.2% on savings, what will Bob and Carol give up (opportunity cost) over the 2 years if they pay cash?

e.What is the cost of the cash aernative at the end of 2 years?

f.Should Bob and Carol choose the financing or the cash aernative?

Finance