You are considering the following fixed interest rate mortgage loan alternatives: Alternative 1: $180,000 initial loan balance 4.00% annual nominal interest rate 30-year amortization schedule $859.35 monthly loan payment Alternative 2: $195,000 initial loan balance 4.25% annual nominal interest rate 30-year amortization schedule $959.28 What is incremental cost of borrowing the additional $15,000?     (A) 0.58% --- Wrong (B) 4.25% (C) 5.8% --- Wrong (D) 7.01%

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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You are considering the following fixed interest rate mortgage loan alternatives:

Alternative 1:

  • $180,000 initial loan balance
  • 4.00% annual nominal interest rate
  • 30-year amortization schedule
  • $859.35 monthly loan payment

Alternative 2:

  • $195,000 initial loan balance
  • 4.25% annual nominal interest rate
  • 30-year amortization schedule
  • $959.28

What is incremental cost of borrowing the additional $15,000? 

  
(A) 0.58% --- Wrong
(B) 4.25%
(C) 5.8% --- Wrong
(D) 7.01% 
Expert Solution
Step 1: Concept

In order to calculate the incremental cost of borrowing, we will have to use the difference in the monthly payment as if it is like a monthly bond coupon payment whose current price is $15,000 and face value is zero at the end of the term of 30 years. This will give us the monthly incremental cost of borrowing and then when we multiply it by 12, we will get the annual incremental cost of borrowing the additional funds of $15,000.

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