1) Long-term debt financing involves borrowing money from a financial institutio

Question

1) Long-term debt financing involves borrowing money from a financial institution for a period of time that is greater than one year. In return for borrowing the money, a company promises to pay back the principal along with interest. Loan payments are normally the same from period to period, however the portion of the payment that represents interest decreases with each payment. Explain why interest expenses decrease over the life of the long-term debt. How is interest expense normally calculated (formula)? Explain with an example. (5 points)

Explanation / Answer

Answer

Example data, long term borrowing borrowed $30000 at 10% interest rate to be repaid in 3 instalments of $10000 each in 3 years. Amount outstanding after 3 years will be repaid in one limpsum payments.

Year

Beginning Long term borrowing outstanding (A)

Interest expense (B=Ax10%)

Instalment repaid (C )

Principal part included in instalment (D=C-B)

Ending Long Term Borrowing outstanding [A-D]

1

$30000

$3000

$10000

$7000

$23000

2

$23000

$2300

$10000

$7700

$15300

3

$15300

$1530

$10000

$8470

$6830

Year

Beginning Long term borrowing outstanding (A)

Interest expense (B=Ax10%)

Instalment repaid (C )

Principal part included in instalment (D=C-B)

Ending Long Term Borrowing outstanding [A-D]

1

$30000

$3000

$10000

$7000

$23000

2

$23000

$2300

$10000

$7700

$15300

3

$15300

$1530

$10000

$8470

$6830

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