Question

Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is $420,000. The company can borrow $420,000 for three years at 12 percent annual interest or for one year at 10 percent annual interest. Assume interest is paid in full at the end of each year.

a. How much would Sauer Food Company save in interest over the three-year life of the computer system if the one-year loan is utilized and the loan is rolled over (reborrowed) each year at the same 10 percent rate? Compare this to the 12 percent three-year loan.

10 percent loan
12 percent loan
Interest savings

b. What if interest rates on the 10 percent loan go up to 15 percent in year 2 and 18 percent in year 3? What would be the total interest cost compared to the 12 percent, three-year loan? Fixed-rate 12% loan
Variable-rate loan
Additional interest cost

Answer 1

Loan amount	420,000
Fixed interst rate	12%
Interest	=420000*12%*3	151,200
Variable interst rate	10%
Total outgo	=420000*10%*3	126,000
Saving in Interst	=151200-126000	25,200
If the variable rate is fluctuating
Interst-Year 1	=420000*10%	42,000
Interst-Year 2	=420000*15%	63,000
Interst-Year 3	=420000*18%	75,600
	Total	180,600
Additional Interest cost	=180600-151200	29,400