11. Bank loans Short-term financing through bank loans Consider this case: Centr
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11. Bank loans Short-term financing through bank loans Consider this case: Central Corp. needs to take out a one-year bank loan of $500,000 and has been offered loan terms by two different banks. One bank has offered a simple interest loan of 10% that requires monthly payments. The loan principal will be paid back at the end of the year. Another bank has offered 796 add-on interest to be repaid in 12 equal monthly installments. Based on a 360-day year, what will be the monthly payment for each loan for November? (Hint: Remember that November has 30 days.) Value [ Simple interest monthly payment Add-on interest monthly payment $53,500.00 $46,812.50 $49,041.66 $44,583.33 Choose the answer that best evaluates the following statement Keedsler Motors Inc. always prefers simple interest loans over add-on interest loans because even if the interest rate is higher on the simple interest loan, its monthly payment is lower. O The company needs to be sensitive to interest rate differences between loan types and take them into consideration when deciding what type of loan to take out. The company should only accept add-on interest loans when it cannot get simple interest loans O Apla. A Continue without savingExplanation / Answer
In a simple interest loan, the installments paid every month will cover a portion of the principal amount and simple interest for the remaining period of the loa. Essentially this means that every installment earns the lender a simple interest at the lending rate for the remaining term of the loan.
Therefore, the monthly installment paid at the end of first month will earn the lender interest for the remaining loan period which is (12 - 1) =11 months and so on for every monthly installment.
The summation of all these monthly installments and the interest generated on them for the remaining loan period should be equal to the principal borrowed and the simple interest generated on the loan.
Loan Amount = $500000 , Simple Interest Rate=10 % per annum, Loan Period =1 year, No.of monthly Installments =12. Let the equated monthly installment be K
Therefore, 500000 + (500000 x 12 x 10) /(100 x12) = K + ( K x 11 x 10) /( 100 x 12) + K + ( K x 10 x 10)/ (100 x 12) +................K + (K x 1 x 10) /(12 x 100) + K
Solving this equation K = $43824.701
An add on interest loan unlike a normal loan calculates the interest payable during the loan period and adds this interest to the principal borrowed at the beginning of the borrowing period. This sum of the principal and interest payable is then divided by the loan period to arrive at the equated periodic installments.
Principal Borrowed =$500000, Interest Rate=7% per annum simple interest.
Therefore, Interest on the borrowing = (500000 x 7) / 100 = $35000
Total Amount to be repaid after a year = Principal + Interest = 500000 + 35000 = $ 535000 (to be repaid in 12 monthly equal installments)
Therefore, monthly intsallments = Amount to be repaid / 12 = $44583.33
Keedster Motor Inc. should only accept add on interest loans when it cannot get simple interest loans because in the former the interest component of the repayments is calculated on the orginal principal borrowed and not on the outstanding part of the borrowed amount.This results in a higher effective interest payment as compared to the nominal (or stated) interest rate.
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