CHAPTER 7

Homework : Do questions 1, 2, 5, 7, 8, and 9

For question number 7…please assume that the
bill is received by June 1st. The average daily
balance is computed for 30 days. The balance for
the first 15 days is $300/-, and the balance for the
last 15 days is $200 (since, $100 is paid off on June


1. Dave borrowed $500 for one year and paid $50 in interest. The bank charged him a $5
   service charge. What is the finance charge on this loan?
    $50 + 5 = $55
2. In the above example, Dave borrowed $500 on January 1, 1996, and paid it all back at once
   on December 31, 1996. What was the APR?
    $55 on $500 or 11% APR
    3. If Dave paid the $500 in 12 equal monthly payments, what is the APR?
    4. APR = (2*n*I)/[P(N+1)] = (2*12*55)/[500(12+1)] = 1320/6500=0.203=
                    = 20.3%
4. The first card may not charge an annual fee, but that does not mean that it’s “free?” It
   depends how Bobby plans to use it. He should compare other charges besides the annual fee.
   For example, what is the late payment fee? Over-the-limit fee? Cash advance fee? Some
   cards may even charge him for customer calls. Comparing all the fees charged is important.
   Equally important is the interest rate. If Bobby can lower his interest rate by switching to a
   new card, he can potentially save hundreds of dollars a year, more than making up for the $40
   annual fee.
5.     Sidney’s cash advance fee was $4.00.
       At an 18% APR, she paid $3.00 interest for one month.
       She paid a total of $207.
       If Sydney had made the purchase with her credit card and paid off the bill in full
        promptly, she would have paid only $200.

6. Dorothy Zwayer lacks cash to pay for a $600 dishwasher. She could buy it from the store on
   credit by making 12 monthly payments of $52.74 each. The total cost would then be $632.88.
   Instead, Dorothy decides to deposit $50 a month in the bank until she has saved enough
   money to pay cash for the dishwasher. One year later, she has saved $642—$600 in deposits
   plus interest. When she goes back to the store, she finds that the dishwasher now costs $660.
   Its price has gone up 10 percent—the current rate of inflation. Was postponing her purchase a
   good trade-off for Dorothy?
    No, it was not a good trade-off for Dorothy to postpone her purchase. By waiting one year,
    she had to pay more to buy the dishwasher. Now she had saved $642, but the price of the
    dishwasher has increased from $600 to $660. If she had used credit to buy the dishwasher a
    year before, she would have paid only $632.88.
    However, it is possible that not incurring a debt and not being responsible for monthly
    payments were more important to Dorothy than the money she would have saved if she had
    used credit.
 7. You have been pricing a compact disc player in several stores. Three stores have the exact
    same price of $300. Each of these stores charges 18 percent APR, has a 30-day free ride, and
    sends out bills on the first of the month. On further investigation, you find that Store A
    calculates the finance charge by using the average daily balance method, that Store B uses the
    adjusted balance method, and that Store C uses the previous balance method. Assume that
    you purchased the disc player on May 5 and that you made a $100 payment on June 15. What
    will the finance charge be if you made your purchase from Store A? from Store B? from
    Store C?
    Store A:
    Average Daily Balance              Finance Charge
    ($300 + $200 /2 = $250)            $3.75 ($250  .015)
    Store B:
    Adjusted Balance Method            3.00 ($200  .015)
    ($300 - $100 = $200)
    Store C:
    Previous Balance Method            4.50 ($300  .015)
    ($300 - $0 = $300)
    Remember, Store C does not count the amount you paid during the month and charges
    interest for the entire month on the beginning balance of $300. Note, too that 18 percent APR
    is equivalent to 1.5 percent monthly rate.
 8. What is the interest cost and the total amount due on a six-month loan of $1,500 at 13.2
    percent simple annual interest?
    Using the simple interest formula: I = P x r x T
                                         = $1,500  0.132  1/2 year
                                 Interest = $99.00
                      Total amount due = $1,500 + $99 = $1,599.
9. After visiting several automobile dealerships, Richard Welch selects the car he wants. He
   likes its $10,000 price, but financing through the dealer is no bargain. He has $2,000 cash for
   a down payment, so he needs an $8,000 loan. In shopping at several banks for an installment
loan, he learns that interest on most automobile loans is quoted at add-on rates. That is,
during the life of the loan, interest is paid on the full amount borrowed even though a portion
of the principal has been paid back. Richard borrows $8,000 for a period of four years at an
add-on interest rate of 11 percent.
a.   What is the total interest on Richard’s loan?
b.   What is the total cost of the car?
c.   What is the monthly payment?
d.   What is the annual percentage rate (APR)?
a. What is the total interest on Richard’s loan?
      Cash price                       = $10,000
      Down payment                     = $2,000
      Amount of the loan               = $8,000
      Length of the loan               = 4 years or 48 months
      Quoted add-on interest           = 11 percent
      Total interest: I = P  r  T    = $8,000  0.11  4 = $3,520

b. What is the total cost of the car?
   Total cost = Down payment + total interest + principal
   = $2,000 + $3,520 + $8,000 = $13,520
c. What is the monthly payment?
   Monthly payment = $3,520 + $8,000 divided by 48 = $240

d. What is the annual percentage rate (APR)?
     APR = (2*n*I)/[P(N+1)] = (2*12*3520)/[8000(48+1)] = 84480/392000=0.2155 =

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