Question

1.     In this scenario you will calculate the monthly payment and total interest paid on a car loan. Suppose that you need $15,000 to buy a used vehicle to get back and forth to work and school. You have $7,500 in a money market fund earning 1.00% per year, but you are not sure you want to use any or all of that money.

Using the tables in Exhibit 1-D, located on pp. 42-43 in the Ch. 1 Appendix of Focus on Personal Finance, determine the total amount of payment due at the end of each year, and divide by 12 to estimate the monthly payment for each of the following loan scenarios. Also, calculate the total amount of interest you would pay over the life of each loan. Be sure to show your work for opportunities to earn partial credit, where applicable.

For example, if you have the correct formula but put a decimal in the wrong spot you could earn partial credit. The first row in the table has been completed to demonstrate you how work can be shown.

Loan Amount	Interest Rate	Term	Monthly Loan Payment = Amount Borrowed divided by “Table Factor in Exhibit 1-D” divided by 12	Total Amount of Interest = (Monthly Loan Payment * Term * 12) - Loan Amount
$7,500	6%	3 years	Example: 7500/2.673=2,805.84 2,805.84/12= 233.82	Example: (233.82*3*12) - 7,500= 917.52
$7,500	6%	5 years
$10,000	6%	5 years
$15,000	6%	5 years

2.     Based on the above calculations, the price of the car, and the money available in a money market fund, which loan option would you suggest to someone purchasing a vehicle? Please explain the rationale and considerations for your decision.

3.     In your own words, how would you summarize “opportunity cost”? How does the concept of opportunity cost apply to this decision? Explain in a brief paragraph.

Income Taxes

Each year you will need to file a federal income tax return by April 15^th. While you may use software or a tax preparation professional to help you complete your return, there are still some terms of which you should have a basic understanding. Respond to the following to demonstrate your understanding. Each response should be at least 50 words.    

4.     Explain the differences between taxable income and adjusted gross income.

5.     In your own words, define tax deduction, exemption, and tax credit.

Answer 1

(1)

(b)

The car buyer has insufficient money in the money market fund to purchase the car in all scenarios. Hence, he/she has to madatorily borrow money to purchase the car. The scenario above examines the situation wherein the buyer keeps a portion of the money in the fund so as to keep earning from the same and using these earnings to reduce some of the borrowings liability. As is observable in the table above, the lowest borrowings liability results when the entire fund is withdrawn and only the excess portion of the car price ($ 7500) is borrowed. Further, the borrowings liability is lower for shorter term borrowing. Hence, the first option of borrowing $ 7500 for three years should be chosen as it has the lowest borrowings liability.

(3) Opportunity cost refers to the cost of missing out on an investment opportunity when another investment is chosen over the former. For example if an investor has two investment avenues promising returns of 7 % and 9 % respectively, if the former (7%) is chosen, the latter (9%) is missed out. The opportunity cost is then 9% as the investor misses out on making this return owing to chosing the first investment option over the second.

The opportunity cost in this context is missing out on making 1 % per annum from the money market fund, owing to money withdrawal for the car purchase. Hence, the car buyer's opportunity cost is 1 % per annum in this context.

NOTE: Please rause a separate query for the solution to the remaining unrelated tax question.