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Overview to mini-cases1
Understanding The LawWhen Should A Lender Disclose The Annual Percentage Rate (APR)
Mini-case 1: MortgageRatesUSA.com...........................................................................................5
Overview to mini-cases
One of the best ways to understand interest calculations is to redo other peoples
examples. In mini-cases we present a number of examples from the Web. In each case students
In all of these cases the terminology annual percentage rate (APR) is used. The concept
of APR was designed to make it easier for borrowers to compare the cost of loans from different
** This is a preliminary draft of a case to accompany Principles of Finance with Excel, 2nd
unfortunately the Act does not specify how the APR is to be calculated.
The result of this ambiguity is that there are many concepts of APR. 1 The message of
Chapter 3 and of these cases is that the APR concept is not as meaningful as the effective annual
interest rate (EAIR) for determining the actual cost of financing, the annualized internal rate of
return of the loan payments. Exhibit 1 shows a quote from the Cornell University Law Website
1 The Columbus State University Visa example in Chapter 3 (page 95) is also an illustration of
this.
1. APR is not a uniform concept! There are at least three concepts of APR that crop up
regularly:
APR = Periodic percentage rate * number periods per year. An example is the Columbus
State University credit card discussed in on page 95: There a daily interest rate of
Sometimes (as Mini-case 3), the APR calculated is actually the EAIR.
2. The only interest rate that can be used to compare alternative costs of financing is the
In the questions below, assume that you have taken a $100,000, 30-year mortgage with monthly
payments:
2. What is the monthly interest rate that sets the NPV of the 360 monthly payments = 0? [To
answer this question you should use Excels NPV function and Goal Seek.]
3. What is the effective annual interest rate on the mortgage? (Hint: take
1 monthly rate
12
1
).
4. How did the authors of the Web page arrive at 8.107% APR?
The web page below gives a good definition of APR (and also shows why this concept is NOT a
1. In paragraph 1: Calculate:
2. In paragraph 2:
Compute the monthly IRR, APR and EAIR for both loans (word of warning: the
3. The Web page claims that loan 2 is preferable because the total payments over 60 months on
this loan are lower than that on loan 1. Show that this is wrong.
4. Despite its higher initial cost, you might think that loan 2 is preferable because it has a higher
initial loan amount. Calculate how much you would need to borrow with loan 1 in order to
receive a net amount of $100,000 (you can do this calculation using Goal Seek, but it can also be
done using the formulas of Chapter 2). Doing it this way, show that Loan 1 is preferable.
The Oregon Telco Credit Union has the following Web page:
Show that the Oregon Telco Credit Unions annual percentage rate (APR) is actually the effective