Question

A farmer is considering borrowing money from a bank. Given the following information:

• Initial loan amount is $88,000.
• The loan will be fully amortized in 3 years at 12%.
• Marginal tax rate is 20%.

(i) What is the interest payment in the 1^st year?

a.         $12,672.00                             b.         $13,200.00    

c.          $10,560.00                             d.         None of the answers are correct

  

(ii) What is the principal payment in the 1^st year?

a.         $20,862.97                             b.         $20,041.13    

c.          $4,400.00                               d.         $26,078.71

(iii) What is the loan balance at the end of 1^st year?

a.         $83,600.00                             b.         $67,137.03    

c.          $67,958.87                             d.         $61,921.29

(iv) What is the tax saving in the 1^st year?

a.         $2,640.00                               b.         $2,112.00      

c.          $1,689.60                               d.         None of the answers are correct

Answer 1

Annual payment = loan amount /PVA 12%,3

                 =88000 / 2.40183

                = $ 36638.73

**FInd present value annuity factor from annuity table or using the financial calculator .(I=12%,N=3 ,PMT= 1)

i)Interest payment =Amount outstanding * interest rate

                = 88000*.12 = 10560

correct option is "c"

ii)Principal payment =Amount of installment - interest payment

             = 36638.73-10560

              = 26078.73   [approx to 26078.71)

correct option is "D"

iii)Loan balance = Amount of loan - principal payment

                       = 88000 - 26078.71

                        = 61921.29

correct option is "D"

Iv)Tax saving : 10560 * .20 = 2112

correct option is "b"