Question

Neile looked at his mechanic and sighed. The mechanic had just pronounced a death sentence on his road-weary car. The car had served him well---at a cost of $500 it had lasted through four years of college with minimal repairs. Now, he desperately needs wheels. He has just graduated, and has a good job at a decent starting salary. He hopes to purchase his first new car. The car dealer seems very optimistic about his ability to afford the car payments, another first for him.

The car Neile is considering is $35,000. The dealer has given him three payment options:

1. Zero percent financing. Make a $4000 down payment from his savings and finance the remainder with a 0% APR loan for 48 months. Neile has more than enough cash for the down payment, thanks to generous graduation gifs.

2. Rebate with no money down. Receive a $4000 rebate, which he would use for the down payment (and leave his savings intact), and finance the rest with a standard 48-month loan, with an 8% APR. He likes this option, as he could think of many other uses for the $4000.

3. Pay cash. Get the $4000 rebate and pay the rest with cash. While Neile doesn’t have $35,000, he wants to evaluate this option. His parents always paid cash when they bought a family car; Neile wonders if this really was a good idea.

Q.1: What are the cash flows associated with each of Neile’s three care financing options?

Answer 1

Cash flows associated with Neile's three car financing options
	0 % APR	8% APR	Full Cash Payment
	$	$	$
Down Payment	4000	0	31000
Loan Repayment in 48 months	31000	35000	0
Interest payment @ 8%	0	5600	0
Total Cash flows	35000	40600	31000
Please note that time value of money is not considered in the above workings. Hence the above
cash flows are not directly comparable.
In the first option we are repaying in 48 months an amount of $ 31000. We should find present value
of that amount using an appropriate discount factor. In the second case we are making a total payment
of $ 40600 in 48 months. Hence in these 2 options present value should be found out and added with
down payment to make the figures comparable (Due to lack of information present value working not done)
Note: Interest Calculation	Year 1	Year 2	Year 3	Year 4	Total
Opening Balance	35000	26250	17500	8750
Installments paid (1/4 of Loan)	8750	8750	8750	8750
Balance payable	26250	17500	8750	0
Average balance(Opening+Closing)/2	30625	21875	13125	4375
Interest @ 8% on average balance	2450	1750	1050	350	5600