Nancy Tai has recently opened a revolving charge account ...



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Nancy Tai has recently opened a revolving charge account with MasterCard. Her credit limit is $1000, but she has not charged that much since opening the account. Nancy hasn't had the time to review her monthly statements as promptly as she should, but over the upcoming weekend, she plans to catch up on her work.

In reviewing November's statement, she notices that her beginning balance was $600 and that she made a $200 payment on November 10. She also charged purchases of $80 on November 5, $100 on November 15, and $50 on November 30. She can't tell how much interest she paid in November because she spilled watercolor paint on that portion of the statement. She does remember, though, seeing the letters APR and the number 16%. Also, the back of her statement indicates that interest was charged using the average daily balance method including current purchases, which considers the day of a charge or credit.

1.Assuming a 30-day period in November, calculate November's interest using the average daily balance method. Also, calculate the interest Nancy would have paid with: a) the previous balance method, b) the adjusted balance method.

1. Average daily balance is as follows

|Period |(a) # Days |(b) Balance |(c) x (b) |

|11/01 – 11/04 |4 |$600 |$2,400 |

|11/05 – 11/19 |5 |$600 + $80 = $680 |3,400 |

|11/10 – 11/14 |5 |$680 - $200 = $480 |2,400 |

|11/15 – 11/29 |15 |$480 + $100 = $580 |8,700 |

| 11/30 |1 |$580 + $50 = $630 |630 |

| | | |$17,530 |

|($17,530/30) = $584.33 x .013 = $7.596 |

a. Previous balance method: $600 x .013 = $7.80

b. Adjusted balance method: $600 + $230 - $200 = $630

$630 x .013 = $8.19

Assuming the average balance is increasing, the previous balance method would be preferred since it would provide smaller finance charges.

2.Going back in time, when Nancy was just about to open her account, and assuming she could choose among credit sources that offered different monthly balance determinations, and assuming further that Nancy would increase her outstanding balance over time, which credit source would you recommend? Explain.

What Nancy needs to do is compare the APRs on the loans with the APR on the

credit card. The lowest APR should indicate her best alternative. As seen below, the

credit card carries the lowest APR.

The APRs can be calculated using the worksheet for Figure 6.7 at Winger and Frasca’s Web site.

| |Contract Rate |APR |

|Discount loan |14% |28.8% |

|Add-on loan |12% |21.5% |

|Credit card |16% |16.0% |

The APRs on the loans may also be calculated using a financial calculator.

To finance a $1,000 discount loan at 14% you must repay $1,163 over the term of a year. Monthly payments are $96.90. Enter $1,000 for PV and $96.90 for monthly payment. The calculated annual rate should be 28.8%. (Note: We are determining the APR; therefore, the size of the loan is not important.)

To finance a $1,000 add-on loan at 12% you must repay $1,120 over the term of a year. Monthly payments are $93.33. Enter $1,000 for PV and $93.33 for monthly payment. The calculated annual rate should be 21.5%.

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