Early Withdrawal Cd Penalty

January 3rd, 2011

Question: Buy now or buy later? Interest compounded annually?

A lot is for sale for $28,000; it is projected to sell for $32,000 in two years. The potential buyer has a CD worth $30,000 now, which earns 4% compounded annually and will mature in 2 years. Cashing in the CD now results in the buyer paying an Early Withdrawal Penalty of $600.
Should the buyer purchase the land now or in two years?

Answer: Buying now seems like the better choice. $30,000 – $600 – $28,000 = $1,400 cash left over (which can earn a little/negligible interest.)

2 yrs from now (30,000+1200+1200+48) – 32,000 = only $480 left over after the deal.
See, you don’t really need a calculator for this one. And a good guess reveals that the real inflation rate is about 7% per year, with the land rising from 28,000 to 32,000. The break even price (without the minimal interest on the 1400 {unless you argue the 1400 would earn 4%/year = @ $115} would be 32,480 – 31,080 land = 1400 cash left over.

Granted, if the problem was more complex (more years), calculators would be needed.

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