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Financing Tessa’s Education

At age 19, Tessa Trainor is in the middle of her second year of studies at a community college in Savannah. She has done well in her course work; majoring in pre-business studies, she currently has a 3.75 grade point average. Tessa lives at home and works part-time as a filing clerk for a nearby electronics distributor. Her parents can’t afford to pay any of her tuition and college expenses, so she’s virtually on her own as far as college goes. Tessa plans to transfer to the University of Tennessee next year. (She has already been accepted.) After talking with her counselor, Tessa feels she won’t be able to hold down a part-time job and still manage to complete her bachelor’s degree program at UT in two years. Knowing that on her 22nd birthday, she will receive approximately $35,000 from a trust fund left her by her grandmother; Tessa has decided to borrow against the trust fund to support herself during the next two years. She estimates that she’ll need 25,000 to cover tuition, room and board, books and supplies, travel, personal expenditures, and so on during that period. Unable to qualify for any special loan programs, Tessa has found two sources of single-payment loans, each requiring a security interest in the trust proceeds as collateral. The terms required by each potential lender are as follows:

a. Tennessee State Bank will lend 30,000 at 6 percent discount interest. The loan principal would be due at the end of two years.

b. National Bank of Knoxville will lend 25,000 under a two-year note. The note would carry a 7 percent simple interest rate and would also be due in a single payment at the end of two years.

Critical Thinking Questions

1. How much would Tessa (a) receive in initial loan proceeds and (b) be required to repay at maturity under the Tennessee State Bank loan?

2. Compute (a) the finance charges and (b) the APR on the loan offered by Tennessee State Bank.

3. Compute (a) the finance charges and (b) the APR on the loan offered by the National Bank of ­Knoxville. How big a loan payment would be due at the end of two years?

4. Compare your findings in Questions 2 and 3, and recommend one of the loans to Tessa. Explain your recommendation.

5. What other recommendations might you offer Tessa regarding disposition of the loan proceeds?


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