Question

Your best friend consults you for investment advice. You learn that his tax rate is 35%35 \%, and he has the following current investments and debts:

  • A car loan with an outstanding balance of $5000\$ 5000 and a 4.86%4.86 \% APR (monthly compounding)

  • Credit cards with an outstanding balance of $10,000\$ 10,000 and a 14.89%14.89 \% APR (monthly compounding)

  • A regular savings account with a $30,000\$ 30,000 balance, paying a 5.51%5.51 \% EAR

  • A money market savings account with a $100,000\$ 100,000 balance, paying a 5.18%5.18 \% APR (daily compounding)

  • A tax-deductible home equity loan with an outstanding balance of $25,000\$ 25,000 and a 5.09%5.09 \% APR (monthly compounding)

a. Which savings account pays a higher after-tax interest rate?

b. Should your friend use his savings to pay off any of his outstanding debts? Explain.

Solution

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Answered 1 year ago
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In this exercise, we are asked to calculate different after-tax interest rates based on the inputs given.

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