Question

7.        Calculate the annual purchasing power over the term of a 5-year loan of provided to Shane Kavanagh, a 37-year old bricklayer. The interest-only loan of $80,000 requiring annual repayments in arrears was made by the Beneficial Finance Agency on a variable interest rate basis. The variable interest rate over the loan term was as follows:

            Details             Year 1              Year 2              Year 3              Year 4              Year 5

            Interest rate       7%                    8%                 8.5%               9.2%                  9%

            Other details over this period are shown below:

            Details             Year 1              Year 2              Year 3              Year 4              Year 5

            Inflows:

            Salary              $65,000           $75,000           $82,000           $88,000           $90,000

            Investments     $5,000              $10,000           $12,000           $11,000           $78,000

            Outflows:

            Taxation          $ 8,000           $10,000           $14,000           $16,000           $15,000

Answer 1

For the Interest only loan, only interest is to be paid periodically. Principal needs to be repaid at the end of the term of the loan. In the instant case, interest is to be paid annually, in arrears. This means interest is to be paid at the end of each year. Principal is to be repaid at the end of year 5.

Purchasing power is the net surplus of each year, after meeting all the loan obligations. Purchasing power of each year is as follows:

Year 1: $56,400

Year 2:$68,600

Year 3: $73,200

Year 4: $75,640

Year 5: $65,800

Computation as follows: