Question

Corp10 is buying custom-built machinery with a contract purchase price of $943,420. The manufacturer has offered the company a payment plan that would require five annual beginning-of-year payments of $200,000 each.

a. If the company accepts the offer, what will be the total amount of interest expense it will incur over the five-year life of the loan?

b. If the company can buy the machinery outright by obtaining outside financing elsewhere at 2%, should it do or should it accept the manufacturer’s offer instead? Explain briefly?

Answer 1

a) Total contract price or loan amount = 943420

total payment = 5*200000 = 1000000

so interest = 1000000- 943420 = 56580

the total interesst is 56580$

b) lets assume that the company is financing outside

then the loan repayment scheule will be

year	payment(in $)	interest ( in $)	principle portion ( in $)	principle o/s ( in $)
0	200000	0	200000	743420
1	200000	(743420*2%) =14868.4	185131.6	558288.4
2	200000	(558288.4*2%) =11165.76	188834.23	369454.16
3	200000	(369454.16*2%) =7389.08	192610.91	176843.24
4	180380.10	(176843.24*2%) = 3536.86	176843.24	0
Total		36960.1

since the payments are at the begining of the year payemnt schedule start from year 0

Total interest when the compant financed outside is less than the previous one so the company should prefer financing outside