Nancy Tai has recently opened a revolving charge account with MasterCard. Her credit limit is $1000, but she has not charged that much since opening the account. Nancy hasn't had the time to review her monthly statements as promptly as she should, but over the upcoming weekend, she plans to catch up on her work.
In reviewing November's statement, she notices that her beginning balance was $600 and that she made a $200 payment on November 10. She also charged purchases of $80 on November 5, $100 on November 15, and $50 on November 30. She can't tell how much interest she paid in November because she spilled watercolor paint on that portion of the statement. She does remember, though, seeing the letters APR and the number 16%. Also, the back of her statement indicates that interest was charged using the average daily balance method including current purchases, which considers the day of a charge or credit.
Assuming a 30-day period in November, calculate November's interest. Also, calculate the interest Nancy would have paid with: a) the previous balance method, b) the adjusted balance method.
Going back in time, when Nancy was just about to open her account, and assuming she could choose among credit sources that offered different monthly balance determinations, and assuming further that Nancy would increase her outstanding balance over time, which credit source would you recommend? Explain.
An EXCEL spreadsheet is very useful for these types of calculations. First, determine the balance of the account for every day in the month. Calculate the average (sum the 30 balances and divide by 30). Multiply by the APR interest rate divided by 12.
Under most circumstances, including a growing outstanding balance, the adjusted balance method should be the most desireable by the consumer. Do the math.
To calculate November's interest using the average daily balance method, you need to determine the daily balance of Nancy's account for each day in November. Here's how you can do it using an Excel spreadsheet:
1. Open a new Excel spreadsheet and create a column for the dates of November (from November 1 to November 30).
2. In the column next to the dates, enter the respective account balances for each day. Start with the beginning balance of $600.
3. For each day, calculate the balance by adding any new purchases and subtracting any payments made that day. For example, on November 5, the balance would be $600 + $80 = $680.
4. Continue calculating the daily balances until you reach November 30.
Once you have the daily balances, calculate the average daily balance by summing up all the daily balances and dividing by 30:
Average Daily Balance = (Sum of Daily Balances) / 30
Next, multiply the average daily balance by the APR interest rate divided by 12 to get the monthly interest:
Monthly Interest = (Average Daily Balance) * (APR / 12)
Since the spilled paint obscured the specific interest charges on the statement, we need to use the average daily balance method to calculate the interest. With the given information, you can compute November's interest using the above steps in Excel.
Now, let's calculate the interest Nancy would have paid with the previous balance method and the adjusted balance method:
a) Previous Balance Method:
Under the previous balance method, the interest is calculated based on the balance at the end of the last billing cycle (in this case, October's ending balance of $600). Multiply this balance by the APR interest rate divided by 12:
Interest with Previous Balance Method = $600 * (APR / 12)
b) Adjusted Balance Method:
Under the adjusted balance method, the interest is calculated based on the outstanding balance after adjusting for any payments made during the current billing cycle. In this case, the outstanding balance after the $200 payment on November 10 would be:
Outstanding balance = $600 (beginning balance) + $80 + $100 + $50 - $200 (payment) = $630
Multiply this adjusted balance by the APR interest rate divided by 12:
Interest with Adjusted Balance Method = $630 * (APR / 12)
To compare the two methods, you can simply compute both interests using the above formulas.
As for choosing a credit source when opening the account, assuming Nancy would increase her outstanding balance over time, the adjusted balance method would be more desirable. This is because the adjusted balance method takes into account payments made during the billing cycle, resulting in lower interest charges compared to the previous balance method, which only considers the balance at the end of the previous billing cycle.
Calculating interest and comparing different credit sources accurately requires detailed knowledge of the specific terms and conditions of each credit source. It's always recommended to review and compare the terms and conditions of different credit sources before making a decision.