Major Capital Purchases

This calculator directly illustrates the effect of similar cash flows directed toward paying cash or financing a major capital purchase. It proves that with equivalent saving and financing rates, both short and long-term net worth remains the same between each scenario. It also graphically shows that accelerating payments does not improve one's net financial position - assuming the same additional cash flow would be saved.

There are only two ways to make a major purchase - you will either pay cash or finance. It is commonly believed that paying cash for a major purchase leads to a stronger future financial position. Let's explore both scenarios side-by-side to see how they compare.

Let's assume someone has $30,000 in an account earning 5% interest and they desire to purchase a $30,000 car.

If they decide to finance the car at 5% interest over 5 years, they will begin with their original $30,000 in their account and a $30,000 liability for the car loan, monthly payments of $566.14 to pay back the loan, and a beginning net worth of zero. If they pay cash, they will begin with nothing in their account, no liability, $566.14 cash flow available to contribute back to their account, and a beginning net worth of zero.

At the end of the first year, had they financed, their account balance would have grown to $31,535 and their outstanding liability would have dropped to $24,583, resulting in a net worth of $6,952. If they paid cash, their monthly contributions of $566.14 plus interest earned would have grown their account to $6,952, resulting in the same net worth as financing.

As we move forward in time the pattern continues - the resulting net worth is the same for both scenarios. Paying cash did not out perform financing (or vice versa.)

But what if one accelerates payments on the loan? It's still the same result. The liability is satisfied sooner, but the long-term financial position remains the same for both strategies. Assuming similar borrowing and growth rates, the only difference between the two scenarios is liquidity, use and control of the existing account balance and the outstanding liability.

Both the pay cash and financing schedules use a monthly mode and are calculated in worksheet fashion using the following basic equations:

Pay Cash Scenario

Beginning Balance = Initial Balance - Purchase Amount or previous period end-of-period balance

Growth = Beginning Balance * (Rate of Return / 12)

Ending Balance = Beginning Balance + Growth + Monthly Contribution [same as loan payment]

Net Worth Beginning or End of Period = Pay Cash Balance at beginning or end respectively

Financing Scenario

Loan Beginning Balance = Purchase Amount or previous period end-of-period balance

Loan Payment = Stated Monthly Pmt or remaining partial payment to satisfy loan

Loan Ending Balance = Loan Beginning Balance * (1+Interest Rate / 12) - Loan Payment

Financing Beginning Balance = Initial Balance or previous period end-of-period balance

Financing Growth = Beginning Balance * (Rate of Return / 12)

Financing Ending Balance = Beginning Balance + Growth + Monthly Pmt - Loan Payment

Financing Net Worth Beginning or End of Period = Financing Balance - Loan Balance at beginning or end respectively