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L10: Debt Management

This guide provides an in-depth look at debt management through practical loan analysis examples in the field of engineering economics. Utilizing a case study on a $20,000 loan with an APR of 8.5% over 48 months, the calculations of annuity payment (A), lump-sum payment, and a comparison between buying and leasing options are illustrated. Key financial concepts such as interest payments, principal payments, and effective interest rates are explored to aid in informed financial decision-making.

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L10: Debt Management

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  1. L10: Debt Management ECON 320 Engineering Economics Mahmut Ali GOKCE Industrial Systems Engineering Computer Sciences

  2. Debt Management

  3. $20,000 48 1 2 24 25 0 Applications—Loan Analysis Given: APR = 8.5%, N = 48 months, and P = $20,000 Find: A A = $20,000(A/P,8.5%/12,48) = $492.97

  4. $20,000 48 1 2 24 25 0 Suppose you want to pay off the remaining loan in lump sum right after making the 25th payment. How much would this lump be? $492.97 $492.97 25 payments that were already made 23 payments that are still outstanding P = $492.97 (P/A, 0.7083%, 23) = $10,428.96

  5. Example 3.7 Loan Repayment Schedule $5,000 i = 1% per month 1 2 3 4 5 6 7 22 23 24 0 A = $235.37

  6. Practice Problem • Consider the 7th payment ($235.37) • (a) How much is the interest payment? • (b) What is the amount of principal payment?

  7. $5,000 i = 1% per month 1 2 3 4 5 6 7 22 23 24 0 A = $235.37 Solution Interest payment = ? Principal payment = ?

  8. Solution

  9. Cash Outlay for Buying : $25,886 Down payment: $2,100 Car Loan at 8.5% (48 payments of $466): $22,368 Sales tax (at 6.75%): $1,418 Accounting Data - Buying vs. Lease • Cash Outlay for Leasing : $15,771 Lease (48 payments of $299) : $14,352 Sales tax (at 6.75%): $969 Document fee: $450 Refundable security deposit (not included in total) : $300

  10. Example 3.9 Buying versus Lease Decision

  11. Which Interest Rate to Use to Compare These Options?

  12. Your Earning Interest Rate = 6% • Debt Financing: Pdebt = $2,000 + $372.55(P/A, 0.5%, 36) - $8,673.10(P/F, 0.5%, 36) = $6,998.47 • Lease Financing: Please = $495 + $236.45 + $236.45(P/A, 0.5%, 35) + $300(P/F, 0.5%, 36) = $8,556.90

  13. Summary • Financial institutions often quote interest rate based on an APR. • In all financial analysis, we need to convert the APR into an appropriate effective interest rate based on a payment period. • When payment period and interest period differ, calculate an effective interest rate that covers the payment period. Then use the appropriate interest formulas to determine the equivalent values

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