# solution

Discussion Case

Karou is considering different options for financing the \$12,000 balance on her planned new car purchase. The cheapest advertised rate among the local banks is 7 percent for a 48-month car loan. The c;urrent rate on her revolving home equity line is 8.5 percent. Karou is in the 25 percentfederal tax bracket and the 5.75 percent state tax bracket.

Questions

1. Calculate Karou&#39;s monthly car payment using your financial calculator. Compare the payment amount if she uses the 48-month car loan through her local bank versus her home equity line of credit. Assume both loans will amortize over 48 months and use the simple interest method.

2. What is Karou&#39;s income tax savings overthe life ofthe loan if she chooses to use her home equity line of credit to finance the purchase of her new car?

3. Which loan offers the lower payment? Which loan has the lower after-tax cost? Use this information to determine which loan she should choose.

4. In a discussion with her father about financing her new car, Karou was surprised to hear that he once financed a car with the add-on method of interest calculation. He planned to repay the \$2,000 loan within 1 year but was able to do so after 9 months because of a bonus he earned at work. The interest rate was 5 percent. Calculate the monthly payments, as well as the final payment to pay off the loan. How much interest was “saved,” or rebated, using this method offinancing and the rule of 78s?

5. Assume Karou&#39;s father could finance \$2,000 today at 5 percent using the simple interest method of calculation. How much would the payments be? Calculate the final payment to pay offthe loan after 9 months. How much interest was “saved”?

6. Considering the information in questions 4 and 5, calculate the difference in finance charges assuming neither loan was paid off early.

7. Assuming Karou did not have access to a home equity line, whatfactors might she consider to reduce the lender&#39;s risk and, therefore, “buy” herself a lower-cost loan? (Hint: Consider Principle 8: Risk and Return Go Hand in Hand).

8 . What is the collateral for each of the loans Karou is considering? If the bank repossessed her car, would she still have to repay her loan?

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