Sauer Food Company has decided to buy a new computer system with an expected lif

Question

Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is $270,000. The company can borrow $270,000 for three years at 13 percent annual interest or for one year at 11 percent annual interest. Assume interest is paid in full at the end of each year. a. How much would Sauer Food Company save in interest over the three-year life of the computer system if the one-year loan is utilized and the loan is rolled over (reborrowed) each year at the same 11 percent rate? Compare this to the 13 percent three-year loan Answer is complete and correct. 11 percent loan 13 percent loan Interest savings Interest $ 89,100 $ 105,300 $16,200 b. What if interest rates on the 11 percent loan go up to 16 percent in year 2 and 19 percent in year 3? What would be the total interest cost compared to the 13 percent, three-year loan?

Explanation / Answer

b) Case1: When interest rate is 11% for 1st year, 16% for 2nd year and 19% for 3rd year

1st year: 2,70000x 11x 1/100 =$ 29,700

2nd year: 270000x 16x 1/100 =$43,200

3rd year: 270000x19x 1/100=$ 51,300

Total interest for 3 years (29700+43200+51300)=$1,24,200

Case 2: When interest rate is 13% for 3 year loan

=270000x13x3/100= $1,05,300

total interest cost in case 1 would be $1,24,200 as compared to $105300 in case 2

case 1 $1,24,200 case 2 $ 1,05,300 interest saving $ 18,900

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