Question

1. Your friend has just purchased a house and has incurred a $150,000, 4.5% mortgage payable at $760.03 per month. After making the first monthly payment, he receives a statement from the bank indicating only $197.53 had been applied to reducing the principal amount of the loan. Your friend then calculates that at the rate of $197.53 per month, it will take 63 years to pay off the $150,000 mortgage. Discuss and explain whether your friend’s analysis is correct or not.

2. Discuss and explain why a company may choose to raise capital by issuing bonds instead of issuing stock.

Answer 1

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We know formula for equal monthly instalment is-
PMT=	PV*i
	1-(1+i)^-n
PMT=	Monthly instalment payments
PV=	150,000.00	Loan Value
i=	0.00375	4.5%/12	4.5%/12
n=	?
PMT=	760.03
760.03=	150000*0.00375
	(1-(1+0.00375)^-n
760.03=	562.5
	(1-(1.00375)^-n
((1-(1.00375)^-n)=	0.740102364
1-0.740102364=	(1.00375)^-n)
0.259897636=	(1.00375)^-n)
Solving the equation we will get 'n'= 360 months. It means 30 years.
So, it will take 30 years to pay off $ 150,000.
The analysis is incorrect because in case of home loan the interest portion is adjusted with monthly payment first then the principle amount. As time passes the interest amount is exhausted and then the adjustment of principle amount becomes more.
In this way loan will be paid off in 30 years as shown above.
Discuss and explain why a company may choose to raise capital by issuing bonds instead of issuing stock:
Issuing stock means granting proportional ownership in the firm to investors in exchange for money. From a corporate perspective, perhaps the most attractive feature of stock issuance is that the money generated from the sale of stock does
not need to be repaid. There are, however, downsides to stock issuance that may make bonds the more attractive proposition. With bonds, companies that need to raise money can continue to issue new bonds as long as they can find investors
willing to act as lenders. The issuance of new bonds has no effect on ownership of the company or how the company is operated. Stock issuance, on the other hand, puts additional stock shares in circulation, which means that future earnings
must be shared among a larger pool of investors. This can result in a decrease in earnings per share (EPS), putting less money in owners' pockets.
Issuing more shares also means that ownership is now spread across a larger number of investors, which often makes each owner’s share worth less money. Since investors buy stock to make money, diluting the value of their investments is not
a favorable outcome. By issuing bonds, companies can avoid this outcome.