Question

Consider this case:

Tangle Transcontinental Corp. needs to take out a one-year bank loan of $500,000 and has been offered several different terms. One bank has offered a loan with 9% simple interest that requires monthly payments. The loan principal will be paid back at the end of the year.

Based on a 360-day year, what will be the monthly payment for June? (Hint: Remember that June has 30 days.)

$3,562.50

$3,187.50

$3,750.00

$3,375.00

Another bank has offered 6% add-on interest to be repaid in 12 equal monthly installments. What is the monthly payment on this add-on interest loan?

$37,541.67

$41,958.34

$44,166.67

$39,750.00

Choose the answer that best evaluates the following statement:

A bank loan officer has been approached by a start-up company that needs a five-year loan to purchase the equipment for its first project. The project will have a life of five years. At the end of five years, the equipment will be worthless. The founders of the company told the loan officer that they would be willing to pay a much higher interest rate on a simple interest loan rather than contracting to an add-on interest loan.

a. The loan officer should offer the company a simple interest loan. The bank will make more money in the long run, because it can charge a much higher interest rate.

b. The loan officer should offer the company an add-on interest loan because there is a high risk that the company will not be able to repay the principal on the loan at the end of the project’s life.

Answer 1

Part 1:

Bank Loan = $500,000

Simple Interest = 9%

Time = 30/360

Monthly payment for June = 500000*9%*30/360 = $3,750

Part2:

Bank Loan = $500,000

Add-on Interest = 6%

Time = 12 months

Total interest = 500000*6%*1 = 30000

Monthly payment for add-on interest loan = (Bank Loan + Interest) / number of payments

Monthly payment for add-on interest loan = (500000 + 30000) /12 = $44166.67

Monthly payment for add-on interest loan = $44166.67

Part3:

As given,

1. the company is a start-up company

2. the project will have a life of five years. At the end of five years, the equipment will be worthless.

Considering above points, it may be referred that the company may not be able to repay the principal on the loan at the end of the project’s life.

Hence, the loan officer should offer the company an add-on interest loan as it does not accumulate the principal till end of the project’s life.