This case draws on material from Chapters 3-7

Adam Rust looked at his mechanic and sighed. The mechanic had just pronounced a
death sentence on this road-weary car. The car had served him well-at a cost of $500
it had lasted through four years of college with minimal repairs. Now, he desperately
needs wheels. He has just graduated, and has a good job at a decent starting salary. He
hopes to purchase his first new car. The car dealer seems very optimistic about this
ability to afford the car payments, another first for him.

The car Adam is considering to buy is $35,000. The dealer has given him three
payment options:

1. Zero percent financing. Make a $4,000 down payment from his savings and
finance the remainder with a 0% APR loan for 48 months. Adam has more
than enough cash for the down payment, thanks to generous graduation gifts.
2. Rebate with no money down. Receive a $4,000 rebate, which he would use for
the down payment (and leave his savings intact), and finance the rest with a
standard 48-month loan, with an 8% APR. He likes this option, as he could
think of many other uses for the $4,000.
3. Pay cash. Get the $4,000 rebate and pay the rest with cash. While Adam does
not have $35,000, he wants to evaluate this option. His parents always paid
cash when they bought a family car; Adam wonders if this really was a good
idea.

Adams fellow graduate, Jenna Hawthorne, was lucky. Her parents gave her a car for
graduation. Okay, it was a little Hyundai, and definitely not her dream car, but it was
serviceable, and Jenna didnt have to worry about buying a new car. In fact, Jenna has
trying to decide how much of her new salary she could save. Adam knows that with a
hefty car payment, savings for retirement would be very low on his priority list. Jenna
believes she could easily set aside $3000 of her $45000 salary. She is considering
putting her savings in a stock fund. She just turned 22 and has a long way to go until
retirement at age 65, and she considers this risk level reasonable. The fund she is
looking at has earned an average of 9% over the past 15 years and could be expected
to continue earning this amount, on average. While she has no current retirement
savings, five years ago Jennas grandparents gave her a new 30-year U.S. Treasury
bond with a $10,000 face value.

Jenna wants to know her retirement income is she both (1) sells her Treasury bond at
its current market value and invests the proceeds in the stock fund and (2) saves an
additional $3000 at the end of each year in the stock fund from now until she turns 65.
Once she retires, Jenna wants those savings to last for 25 years until she is 90.

Both Adam and Jenna need to determine their best options.

Case Questions

1. What are the cash flows associated with each of Adams three car financing
options?
2. Suppose that, similar to his parents, Adam had plenty of cash in the bank so
that he could easily afford to pay cash for the car without running into debt
now or in the foreseeable future. If his cash earns interest at a 5.4% APR
(based on monthly compounding) at the bank, what would be his best
purchase option for the car?
3. In fact, Adam doesnt have sufficient cash to cover all his debts including his
(substantial) student loans, The loans have a 10% APR, and any money spent
on the car could not be used to pay down the loans. What is the best option for
Adam now? (Hint: Note that having an extra $1 today saves Adam roughly
$1.10 next year because he can pay down the student loans. So, 10% is
Adams time value of money in the case.)
4. Suppose instead Adam has a lot of credit card debt, with an 18% APR, and he
doubts he will pay off this debt completely before he pays off the car. What is
Adams best option now?
5. Suppose Jennas Treasury bond has a coupon interest rate of 6.5%, paid semi-
annually, while current Treasury bonds with the same maturity date have a
yield to maturity of 5.4435% (expressed as an APR with semi-annual
compounding). If she has just received the bonds 10th coupon, for how much
can Jenna sell her treasury bond?
6. Suppose Jenna sells the bond, reinvests the proceeds, and then saves as she
planned. If, instead, Jenna earns a 9% annual return on her savings, how much
could she withdraw each year in retirement? (Assume she begins withdrawing
the money from the account in equal accounts at the end of each year once her
retirement begins.)
7. Should Jenna sell her Treasury bond and invest the proceeds in the stock fund?
Give at least one reason for and against this plan.
8. At the last minute, Jenna considers investing in Coca-Cola stock at a price of
$55.55 per share instead. The stock just paid an annual dividend of $1.76 and
she expects the dividend to grow at 4% annually. If the next dividend is due in
one year, what expected return is Coca-Cola stock offering?