# You are considering buying a car from a local auto dealer. The dealer offers you one of…

You
are considering buying a car from a local auto dealer. The dealer offers you
one of
two
payment options:
You
can pay \$30,000 cash.
The
deferred payment plan: You can pay the dealer \$5,000 cash today and a payment
of
\$1,050 at the end of each of the next 30 months.
As an
alternative to the dealer fi nancing, you have approached a local bank, which
is
willing
to give you a car loan of \$25,000 at the rate of 1.25% per month.
a.
Assuming that 1.25% is the opportunity cost, calculate the present value of all
the
payments
on the dealer s deferred payment plan.
b.
What is the effective
You
are considering buying a car from a local auto dealer. The dealer offers you
one of
two
payment options:
You
can pay \$30,000 cash.
The
deferred payment plan: You can pay the dealer \$5,000 cash today and a payment
of
\$1,050 at the end of each of the next 30 months.
As an
alternative to the dealer fi nancing, you have approached a local bank, which
is
willing
to give you a car loan of \$25,000 at the rate of 1.25% per month.
a.
Assuming that 1.25% is the opportunity cost, calculate the present value of all
the
payments
on the dealer s deferred payment plan.
b.
What is the effective interest rate being charged by the dealer? Do this
calculation by
preparing
a spreadsheet like this (only part of the spreadsheet is shownyou have to
do
this calculation for all 30 months):

D E F G H
Month Cash payment
Payment
under
deferred
payment plan
Difference
0 30,000
5,000 25,000
1 0 1,050
-1,050
2 0 1,050
-1,050
3 0 1,050
-1,050
4 0 1,050
-1,050
5 0 1,050
-1,050
6 0 1,050
-1,050
7 0 1,050
-1,050
8 0 1,050
-1,050
Now
calculate the IRR of the difference column; this is the monthlyeffective
interest rate
on the deferred payment
plan.

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