Question

1.19 Valley Rendering, Inc. is considering purchasing a new flotation system for recovering more grease. The company can finance a $150,000 system at 5% per year compound interest or 5.5% per year simple interest. If the total amount owed is due in a single payment at the end of 3 years, (a) which interest rate should the company select, and (b) how much is the difference in interest between the two schemes?

Answer 1

Answer:

Given

Finance amount F=15000

Compound interest rate r =5%

Simple interest rate i=5.5%

Years N=3 (a single payment)

A)

If interest rate is compund than payment after 3 years Pc= F*(1+r)^N

Pc=15000*(1+5%)^3=$17364.38 eq 1

If interest rate is Simple than payment after 3 years Ps= F+F*N*i

Ps=15000+15000*3*5.5%=$17475 eq 2

from equation 1 and 2 it is clear that total payment for compound interest is less than simple interest so company will select compoun interest option.

B)

Interest difference = Ps-Pc=17475-17364.38=$110.625