Question

1. A borrower can obtain an 80 percent loan with an 8 percent interest rate and monthly payments. The loan is to be fully amortized over 25 years. Alternatively, he could obtain a 90 percent loan at an 8.5 percent with the same loan term. The borrower plans to own the property for the entire loan term.

a. What is the incremental cost of borrowing the additional funds? (Hint the dollar amount of the loan does not affect the answer).

b. How would your answer change if two points were charged on the 90 percent loan?

c. How would your answer to part (b) change if the borrower planned to own the property only for five years?

Needs to be answered in Microsoft Excel with calculations.

Answer 1

1a). Since property price does not matter, we assume a price of 1,000,000.

Incremental cost of borrowing additional funds = 12.26%

Calculations:

Formulas:

1b). Incremental cost of borrowing additional funds = 15.35%

Calculations:

Formulas:

1c). In this case, incremental cost of borrowing is 17.96%

For this, we need to calculate the loan balance after 5 years.

Then, for the incremental monthly rate of r,

the difference in monthly payment has to equal the monthly payment calculated using the difference in NA (which will be the PV) and the difference in loan balance after 5 years (which will be the FV). For this, either Goal-Seek or Solver have tp be used.

Calculations:

Formulas: