Question

Consider this case:

Taco Large Inc. needs to take out a one-year bank loan of $550,000 and has been offered loan terms by two different banks. One bank has offered a simple interest loan of 10% that requires monthly payments. The loan principal will be paid back at the end of the year. Another bank has offered 7% add-on interest to be repaid in 12 equal monthly installments. Based on a 360-day year, what will be the monthly payment for each loan for November? (Hint: Remember that November has 30 days.) Value

Simple interest monthly payment _______ (4,812.50; 4,583.33; 5270.83; 3,666.66)

Add-on interest monthly payment _______ (39,233.34; 56,397.92; 49,041,67; 51,493.75)

Choose the answer that best evaluates the following statement:

Kumatsu Motors Inc. needs to borrow $10,000,000. The company has been offered both simple interest and add-on interest loans. The add-on interest loan has a significantly lower interest rate than the simple interest loan.

a.) The company needs to evaluate more factors than just the interest rate before deciding which type of loan it should accept.

b.) The company should accept the add-on interest loan, because it will be paying less money in interest due to the lower interest rate. Grade It Now Save & Continue Continue without saving

Answer 1

Simple interest = PNR/360

Where P=Principal (given as $550,000), N= period (=30 days) and R= Rate of interest (=10%)

Simple interest payment for November= 550,000*30810%/360= $4,583.33

The answer is second option.

Add-on interest monthly payment= (Principal + Interest for whole period )*Number of days/360umber Given, interest rate=7% and number of days=30

Add-on interest payment for November=550,000*(1+7%)*30/360 = $49,041.67

The answer is third option.

Regarding different types of interest calculation:

Simple interest is the interest on actual loan outstanding, for the actual period, without compounding effect. Add-on interest payment is calculated by adding the interest for the whole period to the original loan and dividing by the number of payments. Hence, for a given interest rate, the interest paid will be effectively higher than the amount calculated on the loan amount outstanding. Therefore, total loan period and frequency of payments are important in ascertaining the actual cost.

The answer is option (a): “The company needs to evaluate more factors than just the interest rate before deciding which type of loan it should accept”