PROBLEMS (p. 180)
1. A few years ago, Simon Powell purchased a home for $150,000. Today, the home is worth $250,000.
His remaining mortgage balance is $100,000. Assuming that Simon can borrow up to 75 percent of
the market value, what is the maximum amount he can borrow? (LO 5.2)
Present market value of Simon’s home = $250,000. Simon can borrow up to 75 percent of the market
value, or $187,500. Simon still owes $100,000 mortgage on his home. Therefore, he can borrow an
additional $87,500.
2. Louise McIntyre’s monthly gross income is $3,000. Her employer withholds $700 in federal, state,
and local income taxes and $250 in Social Security taxes per month. Louise contributes $100 per
month for her IRA. Her monthly credit payments for VISA and MasterCard are $65 and $60,
respectively. Her monthly payment on an automobile loan is $375. What is Louise’s debt paymentsto-income ratio? Is Louise living within her means? (LO 5.3)
Louise’s Gross Income
=
$3,000
Less: Income taxes
=
-700
Less: Social Security Tax
=
-250
Less: IRA contribution
=
-100
Net take-home pay
=
$1,950
Her monthly payments on VISA, MasterCard, and a car loan add up to $500 per month. Louise’s debt
payments to income ratio is 500 to 1,950, or 25.6 percent. This ratio exceeds the recommended 20
percent figure. Therefore, Louise is overextended. Her maximum monthly loan and credit card
payments should not be over $390.
3. Robert Sampson owns a $175,000 townhouse and still has an unpaid mortgage of $140,000. In
addition to his mortgage, he has the following liabilities:
Visa
MasterCard
Discover card
Education loan
Personal bank loan
Auto loan
$705
280
505
2,000
300
5,000
Total
$8,790
Robert’s net worth (not including his home) is about $35,000,. This equity is in mutual funds, an
automobile, a coin collection, furniture, and other personal property. What is Robert’s debt-to-equity
ratio? Has he reached the upper limit of debt obligations? Explain. (LO 5.3)
Robert’s total debt (not including mortgage) is $8,790. His net worth (not including his home) is
$35,000. Therefore, his debt-to-equity ratio is $8,790 divided by $35,000, or 0.25. Since this ratio is
less than 1, Robert has not reached the upper limit of debt obligations.
4. Madeline Rollins is trying to decide whether she can afford a loan she needs in order to go to
chiropractic school. Right now Madeline is living at home and works in a shoe store, earning a gross
income of $920 per month. Her employer deducts a total of $150 for taxes from her monthly pay.
Madeline also pays $105 on several credit card debts each month. The loan she needs for physical
therapy school will cost an additional $150 per month. Help Madeline make her decision by
calculating her debt payments-to-income ratio with and without the college loan. (Remember the 20
percent rule.) (LO 5.3)
Madeline’s debt payments-to-income ratio with the college loan is 31.85 percent; without the college
loan it is 14.07 percent. According to the 20 percent rule, she cannot afford the college loan.
However, after Madeline pays off her credit card debts, her debt payments-to-income ratio with the
college loan will be 17.5 percent. Therefore, once she pays off her credit cards, she will be able to
afford the loan. [ANSWER: 19.48%]
5. Joshua borrowed $500 for one year and paid $25 in interest. The bank charged him an $8 service
charge. What is the finance charge on this loan? (LO 5.4)
= $33
6. In problem 5, Joshua borrowed $500 on January 1, 2012, and paid it all back at once on December
31, 2012. What was the APR? (LO 5.4)
6.6% APR
7. In problem 5, if Joshua paid the $500 in 12 equal monthly payments, what is the APR? (LO 5.4)
= 12.2%
8. Sidney took a $200 cash advance by using checks linked to her credit card account. The bank charges
a 2 percent cash advance fee on the amount borrowed and offers no grace period on cash advances.
Sidney paid the balance in full when the bill arrived. What was the cash advance fee? What was the
interest for one month at an 18 percent APR? What was the total amount she paid? What if she had
made the purchase with her credit card and paid off her bill in full promptly? (LO 5.4)

Sidney’s cash advance fee was $4.00.



At an 18% APR, she paid $3.00 interest for one month.
She paid a total of $207.
If Sydney had made the purchase with her credit card and paid off the bill in full promptly, she
would have paid only $200
The answer is true if the card has a grace period, but if there is no grace period (and some cards don’t
offer one), she would have paid the $3 interest charge regardless and would have saved only on the
cash advance of $4.
9. Brooke lacks cash to pay for a $500 washing machine. She could buy it from the store on credit by
making 12 monthly payments of $44.85 each. The total cost would then be $538.20. Instead, Brooke
decides to deposit $42 a month in the bank until she has saved enough money to pay cash for the
washing machine. One year later, she has saved $516—$504 in deposits plus interest. When she goes
back to the store, she finds that the washing machine now costs $550. Its price has gone up 10
percent—the current rate of inflation. Was postponing her purchase a good trade-off for Brooke? (LO
5.4)
No, it was not a good trade-off for Brooke to postpone her purchase. By waiting one year, she had to
pay more to buy the washing machine. Now she had saved $516, but the price of the washing
machine has increased from $500 to $550. If she had used credit to buy the washing machine a year
before, she would have paid only $538.20.
However, it is possible that not incurring a debt and not being responsible for monthly payments were
more important to Brooke than the money she would have saved if she had used credit.
10. What are the interest cost and the total amount due on a six-month loan of $1,500 at 13.2 percent
simple annual interest? (LO 5.4)
Using the simple interest formula: I = P x r x T
Interest = $99.00
Total amount due = $1,599.
11. After visiting several automobile dealerships, Richard 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. (LO 5.4)
a. What is the total interest on Richard’s loan?
b. What is the total cost of the car?
c. What is the monthly payment?
d. What is the annual percentage rate (APR)?
a. What is the total interest on Richard’s loan?
Cash price
Down payment
Amount of the loan
Length of the loan
Quoted add-on interest
Total interest: I = P  r  T
= $10,000
= $2,000
= $8,000
= 4 years or 48 months
= 11 percent
= $3,520
b. What is the total cost of the car?
Total cost = Down payment + total interest + principal
= $13,520
c. What is the monthly payment?
Monthly payment = $240
d. What is the annual percentage rate (APR)?
APR

2 N  I
= 21.55%
P (N  1)