A bank is in the process of renegotiating a loan. The principal outstanding is $

Question

A bank is in the process of renegotiating a loan. The principal outstanding is $50 million and is to be paid back in two installments of $25 million each, plus interest of 8 percent. The new terms will stretch the loan out to 5 years with no principal payments except for interest payments of 6 percent for the first three years. The principal will be paid in the last two years in payments of $25 million along with the interest. The cost of funds for the bank is 6 percent for both the old loan and the renegotiated loan. An up-front fee of 1 percent is to be included for the renegotiated loan.
a. What is the present value of the existing loan for the bank?

Explanation / Answer

The present value of the loan prior to rescheduling is: Payment in Year 1: Principal + Interest = $25m + 0.08 * $50 = $29m Payment in Year 2: Principal + Interest = $25m + 0.08 * $25 = $27m PV = PVn=1, k=6 ($29) + PVn=2, k=6 ($27) = $51.3884 million

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