I need answer to the following question. 1. Explain the rule of 72. Assuming an

Question

I need answer to the following question.

1. Explain the rule of 72. Assuming an interest rate of 7% how long will it take you to double your money? How long at 12%? Why does a longer term loan or investment carry a higher interest rate?

2. Assuming you have negotiated the factors that can be negotiated, does it make more sense to lease or buy your $30,000 personal car over 48 months given the following factors :

Lease: Security payment (from your cash or trade in) of $2,500, total monthly payments of $23,000, end of lease payment of $1,000

Buy: Down payment of $2,500, interest rate of 6.5%, money factor from p.98, estimated car value at end of loan of $13,000

Explanation / Answer

Answer for point no.1:

Rule of 72 gives the time within which the amount invested gets doubled. This is arrived by dividing 72 with the rate of interest.

Given interest rate of 7%, it would take 72/7 = 10.29 i.e, 10years 4 months approximately, for the amount to get doubled.

Given interest rate of 12%, it would take 72/12 =6 years approximately for the amount to get doubled.

Long tem loan or investment carry a higher rate of interest is the risk non repayment is more. As risk is directly proportionate to return, the higher the risk, higher the return.

Answer for questionno 2:

Cash outflow on account of lease:

Security payment + Total montly payments+End of lease payment

=$2,500+$23,000+$1,000

=$26,500.

Cash ouflow if the car is bought:

Down payment+instalment *48 - Car value at the end of the loan

=$2,500+PMT(6.5%/12,48,27,500) *48 - $13,000

=$2,500+$652.16 *48 -$13,000

=$2,500 +$31303.68 -$13,000

=$20,803.68

As the cash outflow is more in the case of lease, it makes more sense to buy the car.

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