Problem Set 3

1. Louise McIntyres monthly gross income is $2,000. Her employer withholds $400 in federal,
state, and local income taxes and $160 in Social Security taxes per month. Louise contributes
$80 per month for her IRA. Her monthly credit payments for VISA, MasterCard, and
Discover card are $35, $30, and $20, respectively. Her monthly payment on an automobile
loan is $285. What is Louises debt payments-to-income ratio? Is Louise living within her
means?

Debt Payments-to-Income Ratio = Monthly Credit Payments /Net Monthly Income

ANS.
$2000 (400+160+80) = $1360
$1360 (35+30+20+285) = $370
Debt Payments-to-Income Ratio = 370/1360 = 0.272 = 27.2%
At 27% Louise is spending 7% over the recommended 20% of net income that she
should be spending on credit payments, so she IS NOT living within her means.
2. Calculating Debt Paymentsto-Income Ratio. Suppose that your monthly net income is
$2,400. Your monthly debt payments include your student loan payment, a gas credit card
and they total $360. What is your debt payments to income ratio?

ANS.
$360/$2400 = 0.15 or 15%
3. Dave borrowed $500 for one year and paid $50 in interest. The bank charged him a $5 service
charge.
A- What is the finance charge on this loan?

ANS.
Amt. of Interest = $50
Service Charge = $5
Finance charge = $55
B- Dave borrowed $500 on January 1, 2006, and paid it all back at once on December 31,
2006. What was the APR?

ANS.
APR = (2*n*I)/P(n+1)

Principal = $500
No. of Payments = 1

Amt. of Interest = $50

Service Charge = $5
2*1*50+5 / 500(1+1) = (2*55) / (500*2) = 110/1000
APR= 0.11 or 11%
C- If Dave paid the $500 in 12 equal monthly payments, what is the APR?

ANS.
Principal = $500
No. of Payments = 12
Amt. of Interest = $50
Service Charge = $5
2*12*50+5 / 500(12+1) = (24*55) / (500*13) = 1320/6500
APR= 0.203 or 20.3%

4. Calculating Simple Interest on a Loan. Damon convinced his aunt to lend him $2,000 to
purchase a plasma digital TV. She has agreed to charge only 6 % simple interest, and he has
agreed to repay the loan at the end of one year. How much interest will he pay for the year?

ANS.
Simple Interest = P * r * T
Loan Amt $2000
Rate of Interest 6%
Time 1year
Interest = $2000 *.06 * 1= $120

5. 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.
Questions

a.

What is the total interest on Richards loan?

Price $10,000
Down Payment $2,000
Loan $8,000
Period 4 years or 48 months
Add-on Interest 11%
Total interest: I = P * r * T
= $8,000 * 0.11 * 4 = $3,520
b. What is the total cost of the car?

$8,000 + $3520 = $11,520 PLUS $2000 down!!!! + 13,250

c.

What is the monthly payment?

$11,520/48 months = $240

d. What is the annual percentage rate (APR)?

APR = 2 * n * I / P (n+1)
2 * 12 * 3520 / 8000(48 + 1)
$84,480 / 392,000 = 0.2155 = 21.55%