Question

1. A construction company borrows $100,000 to purchase equipment with a promise to repay the loan with equal monthly payments over a 6-year period. a. Draw the cash flow diagram b. At an interest rate of 8% compounded monthly, what are the annual payments to pay off the loan in full?

Answer 1

Solution Amount borrowed $100,000 Repayment period 6 Years Required a.: Draw the cash flow diagram Annual Payments Borrowing (Cash inflow) (Cash outflow) 0 2 4 Years Required b.: Computation of Annual payments at interest rate 8% compounded monthly Step-1: Computation of Annual effective interest rate Annual Interest rate 8% Monthly interest rate (8% /12) 0.67% Annual effective interest rate (1+8%/12)^12} - 1 = 8.30 % Step-2: Computation of Present value annuity factor for 6 years@interest rate 8.30% Present Value Annuity factor (Excel formula) PV(8.30%,6,-1,,0)= 4.58111 Step-3: Computation of Annual payment Annual payments = Amount borrowed/ Present value annuity factor $100,000/4.58111 $21,828.75 Annual payments $21,828.75 Note: Intermediary calculations are not rounded off. LO