Question

Oriole Tooling Ltd. is assessing two available options for the purchase of new equipment with a negotiated cash price of $180,000. The manufacturer is willing to accept a down payment of 20% of the purchase price and an instalment note for the balance. The note would require quarterly fixed principal payments (plus interest) starting October 1, 2020, for a period of two years. Oriole has a proposal from its bank for an instalment loan for two years that requires a fixed blended monthly payment (including both principal and interest) starting August 1, 2020. The loan would be for 80% of the equipment’s purchase price. The current market rate of interest is 6%. Both contracts have an interest rate of 6%.

Is there any measurement uncertainty in determining which option is best for Oriole?



Which discounted cash flow approach should be used in the comparison of the two alternatives?

Answer 1

Given the negotiated cash price = 1,80,000

Amount of down payment = 36,000

Amount of Loan = 1,80,000 - 36000 = 1,44,000

Let us prepare a schedule inorder to find out the quarterly payments and interest

Option-1) Quarterly fixed payment plus interest.

Quarter	Opening Principal	Interest @ 1.5%	Principal Repayment	Total Payment	Closing loan balance
1	1,44,000	2,160	18,000	20,160	1,26,000
2	1,26,000	1,890	18,000	19,890	1,08,000
3	1,08,000	1,620	18,000	19,620	90,000
4	90,000	1,350	18,000	19,350	72,000
5	72,000	1,080	18,000	19,080	54,000
6	54,000	810	18,000	18,810	36,000
7	36,000	540	18,000	18,540	18,000
8	18,000	270	18,000	18,270	-

Total interest Charged - 9720

Present value of laon payments

Option-2) Monthly Installment.

The formula for calculating the monthly equalised installments is.

[P x R x (1+R)^N]/[(1+R)^N-1], where P stands for the loan amount or principal, R is the interest rate per month

Given Annual interest is 6% per annum hence monthly interest is 6/12 = 0.5% per month.

(1,44,000 * 0.005 * (1.005)^24)/((1.005)^24 -1)

= 6382

The amortization schedule for this is as follows.

Month	Opening Principal	Interest @ 0.5%	Principal Repayment	Fixed payment	Closing loan balance
1	1,44,000	720	5,662	6,382	1,38,338
2	1,38,338	692	5,690	6,382	1,32,648
3	1,32,648	663	5,719	6,382	1,26,929
4	1,26,929	635	5,747	6,382	1,21,182
5	1,21,182	606	5,776	6,382	1,15,405
6	1,15,405	577	5,805	6,382	1,09,601
7	1,09,601	548	5,834	6,382	1,03,767
8	1,03,767	519	5,863	6,382	97,903
9	97,903	490	5,892	6,382	92,011
10	92,011	460	5,922	6,382	86,089
11	86,089	430	5,952	6,382	80,137
12	80,137	401	5,981	6,382	74,156
13	74,156	371	6,011	6,382	68,145
14	68,145	341	6,041	6,382	62,104
15	62,104	311	6,071	6,382	56,032
16	56,032	280	6,102	6,382	49,930
17	49,930	250	6,132	6,382	43,798
18	43,798	219	6,163	6,382	37,635
19	37,635	188	6,194	6,382	31,441
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