PA 410
PA 410 Fall 2020
Assignment 2
Due Thursday, October 1
Question 1:
(4 points) You just graduated from the University of Arizona. Unfortunately, you have also accumulated a $25,000 student loan over four years. Now you need to start paying it off. Suppose the interest rate on the loan is 5% and you need to pay off the loan in 10 years with equal annual payment every year.
a) What is your annual equal payment? Also draw up an amortization payment schedule of interest and principal payment every year for the 10 years. (2 points)
) As we know, the interest on student loan, up to $2,500 each year, is deducted from your gross income to figure out your adjusted gross income (AGI). Suppose your marginal tax rate for the next ten years after graduation is 20%. Please figure out how much this deduction can save you in federal personal income tax every year for the next 10 years. (1 point)
c) Please say in a few sentences why federal government should allow you to deduct student loan interest payment from your income to calculate your tax liability. (1 point)
Question 2:
(4 points) Suppose Pima County issued a $50 million debt to build a new jail in XXXXXXXXXXThe interest rate on the debt was 6%. The original debt payment schedule was to pay off the debt in 30 years with equal annual payment every year. After five years, the interest rate is now down to 4% in XXXXXXXXXXThe County wants to refinance its debt at this low rate, that is to say to issue a new debt at 4% to pay off what is left of the old debt and then make debt payment on the new debt. If the city can issue a new debt at 4% with a maturity of 25 years beginning in 2020, please figure out:
a) What is the annual level payment on the old debt? (1 point)
) What is the amount of the new debt to be issued in 2020? (1 point)
c) What is the saving in annual payment every year for the next 25 years? (Assume also an equal annual payment on the new debt.) (1 point)
d) Use this case as an example,
iefly comment on why citizens should care about your local government debt management. (1 point)
Question 3:
(2 points) Say the city of Tucson now has an annual budget of $100 million, and by city charter, it cannot spend more than 10% of its budget on debt service, including both principal and interest payment. The city’s existing annual debt payment is $7 million. Suppose the city needs to bo
ow $50 million for a capital project, and the debt will be paid back over 30 years with equal annual payments.
a) If the cu
ent interest rate is 5% for a 30-year loan, can the city afford this new debt? (0.5 point) (You need to provide numbers to support your answer.)
) Suppose the cu
ent interest rate now has dropped to 4%, can the city afford the debt now? (0.5 points) (You also need to provide numbers to support you answer.)
c) Please use this example to explain why lower long-term interest rate is desirable in the face of a weak economy. (1 point)