Question 3:

(2 points) Say the city of Tucson now has an annual budget of $400 million, and by city charter, it cannot spend more than 10% of its budget on debt service, including both principal and interest payment. The citys existing annual debt payment is $30 million. Suppose the city needs to borrow $130 million for a capital project, and the debt will be paid back over 20 years with equal annual payments.

1. If the current interest rate is 5% for a 20-year loan, can the city afford this new debt? (1 point)
2. Suppose the current interest rate now has dropped to 4%, can the city afford the debt now? (0.5 point)
3. Please use this example to explain why lower long-term interest rate is desirable in the face of a weak economy. (0.5 point)