Financing Cash Purchase versus 0% Financing

[smstonypoint]

well we had it out with kubota over it.an the kicker is i had just paid off a bank note 6 months earlier.so i called my banker an told her the deal,an she said write the check.so i made kubota take off $2000 for the intrest.so my banker said dont worry you can get a loan when you need it.

I'm glad to hear that things worked out for you.

Steve

 

[LostInTheWoods]

This posting is motivated buy a recent thread in which the merits of a cash purchase versus 0% financing were discussed. That discussion revealed some confusion/misunderstanding about how the choice between a cash purchase and 0% financing can be evaluated from an economic perspective. Old habits die hard, so if you will indulge a retired professor, I have perceived a "teachable moment."

PFFFT. Like we're gonna believe some guy with a degree in economics and decades of experience.

Get real. :laughing:

 

[smstonypoint]

PFFFT. Like we're gonna believe some guy with a degree in economics and decades of experience.

Get real. :laughing:

Correct.:laughing:

I should have pointed out that I specialized in microeconomics rather than macroeconomics. Whereas a macro-economist is wrong about things in general, a micro-economist is wrong about specific things.

Steve

 

[TripleR]

Facts are meaningless. You could use facts to prove anything that's even remotely true! Homer Simpson

 

[montelatici]

This posting is motivated buy a recent thread in which the merits of a cash purchase versus 0% financing were discussed. That discussion revealed some confusion/misunderstanding about how the choice between a cash purchase and 0% financing can be evaluated from an economic perspective. Old habits die hard, so if you will indulge a retired professor, I have perceived a "teachable moment."

http://www.tractorbynet.com/forums/kubota-buying-pricing/192398-1st-payment-done-5.html

I will work through an example to show how "time value of money" concepts can be used to address the issue. I realize that some (many?) members may not be able to make a cash purchase of a large ticket item. However, the concepts can be applied to other choices.

This is a hypothetical example. You need to evaluate the decision based on your individual circumstances.

I chose a base model L2800 HST-1R for my example. Using the "Build My Kubota" tab at Kubota Tractor Corporation - Tractors | L Series | L2800 L3400 L4400, the MSRP is $15,042.

This model is eligible for either 0% downpayment, 0% interest for 60 months (Finance Promotional Rates) or a $1000 rebate for a cash purchase (Finance Customer Rebates).

Assuming that you have to pay the MSRP to qualify for the special financing, you would have to pay $15,042/60 months = $250.70 a month for each of the next 60 months. Assuming that you can't negotiate a lower price, you would be out $14,042 if you pay cash and take the rebate. [To keep things simple, I'm going to assume that you would pay any sales tax upfront if you finance. Thus, the sales tax is equivalent between the alternatives and can be ignored. I don't know anything about Kubota's requirements regarding insurance if you finance, so I will ignore them. However, the analysis can be modified to accommodate these items.]

A $1 today is worth more today than a $1 in the future if you can invest/ save the $1 today and earn a return/interest. To compare apples and apples, we need to compare the present values of the after-tax cash flows of financing versus a cash purchase.

The present value of the cash purchase outflow is $14,042. So what's the present value of the financing alternative? That involves constant periodic payments beginning next period and so is an ordinary annuity. You can use published annuity tables, a financial calculator, on-line calculators, spreadsheet software, etc. to find the present value.

I will use Excel. The syntax is =pv(periodic interest (discount) rate, # of periods, constant payment amount). The # of periods =60 and the constant payment amount is 250.70. The rub comes in determining the periodic discount rate. This is going to be unique for each individual according to his/her investment alternatives, the "riskiness" of those alternatives, and his/her marginal federal and state income tax rates. Note that the investment/savings opportunity has to allow for monthly withdrawals. A 5-year CD won't hack it.



I will use two alternatives to illustrate, 1% and 10% after-tax annual rates.
The present values are =pv(.01/12,60,250.7) = $14,666.18 and =pv(.1/12,60,250.7) = $11,799.29. Under the first case, it makes sense to pay cash: in the second case, it makes sense to finance.

The present values of the two alternatives are equal at an annual after-tax discount rate of 2.74% (rounded). Supposing your marginal federal/state income rate is 20%, this would correspond to a before-tax rate of 2.74%/.8 = 3.425%. So for this example, if you can earn more than 3.425% on your money before taxes, it pays to take the financing. If you earn less, the cash purchase makes sense.

If there are no questions, class is dismissed.

Steve

PS -- I'm getting old and suffer from senior moments. Please advise me of errors on my part. I'm used to being corrected, having been married for 40+years.

Most tax free muni Funds are getting around 4% today, not that I would recommend them. So, putting the 15K into muni fund earning more than 2.74% per annum points to taking advantage of the interest free financing.

 

[fredhargis]

Your analysis can't be disputed, but on the particular combo I bought last April, there was no rebate offered. My choice was to pay the price: I could do that in cash, or over 60 months at 0%. That choice is much easier to make...there was no downside to the 0%, no complicated ROR formulas to work through either.

 

[unbidden]

Great info and thanks for taking the time to do the figuring. A couple things do come to mind:

Doesn't Kubota require insurance on the tractor if fully financed?

Even given that, there is a X factor in all of this.
X equals the peace of mind of keeping a lump sum of liquid cash on hand for a rainy day. Take the 0% option and keep your cash.

 

[beppington]

ok i got a q for you.i pay cash for everything i buy.so when i bought my new kubota i thought ok ill finance through kubota.well they ran my credit an said i had no credit.so whats the deal with that.

well we had it out with kubota over it.an the kicker is i had just paid off a bank note 6 months earlier.so i called my banker an told her the deal,an she said write the check.so i made kubota take off $2000 for the intrest.so my banker said dont worry you can get a loan when you need it.

I thought a bank note was a loan?

 

[smstonypoint]

Doesn't Kubota require insurance on the tractor if fully financed?

Even given that, there is a X factor in all of this.
X equals the peace of mind of keeping a lump sum of liquid cash on hand for a rainy day. Take the 0% option and keep your cash.

As to the insurance question, I don't know whether it is required. I assume (but do not know for certain) that you could buy the insurance for the same rate if you purchased the tractor without financing. As mentioned in my OP, differences in insurance, if any, could be factored into the analysis. If there are no differences, it is a non-issue.

As an economist, I identify that "X factor" as tastes and preferences. In the thread I linked in my OP, some members indicated that they enjoyed the peace of mind that they get from being debt free. No two of us is alike.

Suppose that the analysis showed that 0% financing had a lower PV of ownership by $AAA and Jack chose to pay cash instead. His opportunity cost of obtaining peace of mind from being debt free is $AAA. His peace of mind is worth at least $AAA to him.

Now suppose that the analysis showed that a cash purchase had a lower PV of ownership by $BBB and Jill chose to finance instead. Her opportunity cost of obtaining peace of mind from her rainy day fund is $BBB. Her peace of mind is worth at least $BBB to her.

Neither Jack nor Jill is acting irrationally IMO.

Steve

 

[Agrantina]

I took the 0% in July and NO money down... I had about 3K but opt out of putting anything down. Insurance was a must with the loan but I would have gotten it anyway.. I have insurance on everthing NO matter a loan or not. Now-I might be different I could not add to my homeowners-dont live on the property and where I do live I couldnt say I use the tractor there.I trailer it ALL the time so not a bad deal for me at $13.00 a month. I only pay the $13 monthly for the life of the loan..if I pay it off early the insurnace stops once the loans paid off.. It is Kubota insurance

AndyG