Financing Linda's Education

At age 19, Linda Sayers is in the middle of her second year of studies at a community college in Phoenix. She has done well in her course work; majoring in prebusiness studies, she currently has a 3.75 grade point average. Linda lives at home and works part-time as a filing clerk for a nearby electronics distributor. Her parents can't afford to pay any of her tuition and college expenses, so she's virtually on her own as far as college goes. Linda plans to transfer to the University of Arizona next year. (She has already been accepted.) After talking with her counselor, Linda feels she won't be able to hold down a part-time job and still manage to complete her bachelor's degree program at Arizona in 2 years. Knowing that on her 22nd birthday she will receive approximately $35,000 from a trust fund left her by her grandmother, Linda has decided to borrow against the trust fund to support herself during the next 2 years. She estimates that she'll need $25,000 to cover tuition, room and board, books and supplies, travel, personal expenditures, and so on during that period. Unable to qualify for any special loan programs, Linda has found two sources of single-payment loans, each requiring a security interest in the trust proceeds as collateral. The terms required by each potential lender are as follows:

a. Arizona State Bank will lend $30,000 at 8% discount interest. The loan principal would be due at the end of 2 years.

b. National Bank of Tucson will lend $25,000 under a 2-year note. The note would carry a 10% simple interest rate and would also be due in a single payment at the end of 2 years.

Critical Thinking Questions:

Question 1. How much would Linda (a) receive in initial loan proceeds and (b) be required to repay at maturity under the Arizona State Bank loan?

Question 2. Compute (a) the finance charges and (b) the APR on the loan offered by Arizona State Bank.

Question 3. Compute (a) the finance charges and (b) the APR on the loan offered by the National Bank of Tucson. How big a loan payment would be due at the end of 2 years?

Question 4. Compare your findings in Questions 2 and 3, and recommend one of the loans to Linda. Explain your recommendation.

Question 5. What other recommendations might you offer Linda regarding disposition of the loan proceeds?