You are buying a car. No Better Deals will give you $500 off the list price on a $10,000 car.
a. You can get the same car from Best Deals if you pay $4,000 down and the rest at the end of two years. If the interest rate were 12 percent, where would you buy the car?
b. Best Deals has revised its offer. You now pay $2,000 down, $3,000 at the end of the first year, and $5,000 at the end of the second year. If the interest rate were still 12 percent, where would you buy the car?
c. No Better Deals, in turn, makes a new offer. You pay $10,000, but you can borrow the sum from the dealer at 0.5 percent per month for thirty-six months even though the going market rate is 1 percent per month, with the first payment made when the car is delivered. If you accept the offer,
(1) What would your monthly payments be?
(2) What would the cost of the car to you be?
The objective of this exercise is not to learn how to use present value tables or the present value macro of a spreadsheet, but rather to explicitly identify the financial decisions underlying the different alternatives.