Question

Q2) (Cost of an intermediate-term loan) The J. B. Marcum Company needs $250,000 to finance a new minicomputer. The computer sales firm has offered to finance the purchase with a $50,000 down payment followed by five annual installments of $59,663 each. Alternatively, the firm’s bank has offered to lend the firm $250,000 to be repaid in five annual installments based on an annual rate of interest of 16 percent. Finally, the firm has arranged to finance the needed $250,000 through a loan from an insurance company requiring a lump-sum payment of $385,080 in 5 years.

a. What is the effective annual rate of interest on the loan from the computer sales firm?

b. What will the annual payments on the bank loan be?

c. What is the annual rate of interest for the insurance company term loan?

d. Based on cost considerations only, which source of financing should Marcum select?

Answer 1

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Answer:

a)

Calculate the effective annual interest rate as follows:

Therefore, the effective annual rate is 15%

Formulas:

b)

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c)

Future value = Present value * (1+ rate)^years

$385,080 = $250,000 *(1+ rate)^5

Rate = ($385,080/$250,000)^(1/5) - 1

Rate = 9.02%

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d)

Option 1. Cost of financing is 15%

Option 2. Cost of financing is 16%

Option 3. Cost of financing is 9.02%

annual rate of interest for the insurance company term loan is less. So select Insurance term loan.