Question

You are the finance manager of your company. Your company is planning for capacity expansion and need to borrow RM850,000 from a local bank. The offered term loan will be amortised in 9 years with a nomimal interest rate of 7.2% p.a. compounded monthly. The final payment will be at the end of Year 9.

1-Based on your working on an amortisation table, how much principal and interest would have your company paid after the first four months of payments?
  

2-If you have a choice, would you prefer to repay the above loan monthly (assume7.2% per year is compounded monthly) or annually (assume 7.2% per year is compounded annually) based on the total interest incurred? What is the main factor that contribute to such a difference in interest?

Answer 1

1]	The monthly payment = 850000*0.006*1.006^108/(1.006^108-1) =	$       10,717
	The amortization table will be as below [for the first four months].
	Month	Beg bal	Interest	Principal repayment	End bal
	1	850000	5100	5617	844383
	2	844383	5066	5651	838732
	3	838732	5032	5685	833048
	4	833048	4998	5719	827329
	Total		20197	22671
	Interest paid in the first 4 months =		20197
	Principal paid in the first 4 months =		22671
	Total amount paid = 10717*108 =		1157436
	Total interest paid = 1157436-850000 =		307436
2]	If annual payments, the annual payment would be:
	= 850000*0.072*1.072^9/(1.072^9-1) =		131576
	Total amount paid would = 131576*9 =		1184181
	Total interest paid = 1184181-850000 =		334181
	As total interest paid is less under the monthly repayment option, it
	would be preferred.
	The reason for the lower total interest is that, the amounts paid under
	the monthly option are seggregated into interest and principal and then
	the amount appropriated towared principal will reduce the principal for
	the second month. That will happen for all the 108 months. As the
	principal gets reduced every month, instead of annually in the case of
	the annual option, the total interest paid under the monthly option will
	be less.