Bella is interested in buying a new motorcycle. She has decided to borrow money

Question

Bella is interested in buying a new motorcycle. She has decided to borrow money to pay the $25,000 purchase price of the bike. She is in the 28% federal income tax bracket. She can either borrow the money at an interest rate of 5% from the motorcycle dealer, or she could take out a mortgage on her home. That mortgage would come with an interest rate of 7%. Interest payments on the mortgage would be tax deductible for Bella, but interest payments on the loan from the motorcycle dealer could not be deducted on Bella's federal tax return.

a. Calculate the after-tax cost of borrowing from the motorcycle dealership.

b. Calculate the after-tax cost of borrowing through a second mortgage on Bella's home.

c. Which source of borrowing is less costly for Bella?

d. Is there any other consideration that Bella ought to think about when deciding which loan to take out to pay for the motorcycle?

Explanation / Answer

a)

Interest is not tax deductible so after tax cost would be 5%.

b)

Interest is tax deductible so after tax cost would be net of taxes:

After tax cost = before tax cost x(1- t)

                           = 0.07 x (1-0.28)

                            = 5.04%

c)

Borrowing from motorcycle dealer is less costly for Bella.

D)

Bella should also think about the tenure of loan repayment and monthky instalment she can afford to pay

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.