Jake Smith bought a car in January 2021 for $40,000. He agreed to finance the car at 0% for that full amount making monthly payments over the next 5 years, that is 60 months. At the time of purchase Jake Smith was refused a “cash discount,” i.e. he offered to pay the $40,000 on the spot in January 2021 if there was a discount by the entity selling the car. The entity selling the car refused. It is now June 2021. Jake Smith is going to contact, not the entity selling the car, but the entity that financed the car. He is going to offer to pay off the unpaid balance of the loan, but is going to offer to pay off the unpaid balance of the loan at less than full value. Suppose he offers to pay off 93% of the loan, we would then say that Jake Smith is seeking a 7% pre-payment discount.

A) What incentive does the entity financing the car have to accept any discount at all?

B) While the 7% was offered as hypothetical above, if you look at market rates today, look at Bank of America for example, what discount rate would you recommend and why?

C) In answering either a. or b. above include the concept of net present value as all or part of your explanation.

Answer rating: 100% (QA)

a The entity financing the car has an incentive to accept a discount because it would receive a lump sum of ... View the full answer