Along with licensing, the purchase of auto insurance for vehicles is required in Canada. Benefits of auto insurance are as follows:
• Safeguards the investment in the automobile.
• Pays for medical expenses in case of an accident
• Covers losses caused by uninsured or underinsured drivers.
• Compensates for damage due to theft, vandalism, or natural disasters.
Quick Courier Service is about to purchase insurance on its new delivery van. Taylor, the manager, has the company’s insurance agent outline three payment plans to provide coverage for the next 12 months.
Plan One requires that the full year’s premium of $4000 be paid at the beginning of the year.
Plan Two allows payment of the annual premium in two installments. The first installment would have to be paid immediately and would amount to one-half of the annual premium, plus a $60 service charge. The second installment would be paid in six months’ time, and would amount to the remaining half of the premium.
Plan Three allows for twelve equal monthly payments of $355 each. These payments would be made on the same date within each month, starting immediately.
Quick Courier Service pays its insurance using Plan One. However, the company realizes that it is missing out on interest it could have earned on this money when it pays the full year’s premium at the beginning of the policy term. Taylor considers this to be the “cost” of paying its bill in one lump sum. Taylor is interested in knowing the cost of its insurance payment options.
Questions
1. Suppose Quick Courier Service could earn 4% p.a. simple interest on its money over the next year. Assume the first premium payment is due today (the first day of the insurance policy term) and the focal date is one year from today. Ignoring all taxes, compute the cost to Quick Courier Service of paying the insurance using each of the three payment plans.
2. Suppose Quick Courier Service expects to earn 2.5% p.a. simple interest on any money it invests in the first three months of this year, and 1.8% p.a. simple interest on any money it invests during the rest of this year. Assume the focal date is one year from today. Which option—Plan One, Plan Two, or Plan Three—will have the least cost for the company?