Companies frequently borrow money under anarrangement that requires them to make

Question

Companies frequently borrow money under anarrangement that requires them to make periodicpayments of “interest only”and then pay the prin-cipal all at once. If Cisco International borrowed$500,000 (identi?ed as loan A) at 10% per yearsimple interest and another $500,000 (identi?ed asloan B) at 10% per year compound interest andpaid
only the interest at the end of each year for3years on both loans,
a) on which loan did thecompany pay more interest,and
b) what was thedifference in interest paid between the two loans

Explanation / Answer

For Loan B loan_B = $500,000 rate_B = 10% yearly compounded FV of Loan at the end of first year = 500,000(1 + rate_A) = 500,000(1+0.1) = $550,000 First payment = 550,000 - 500,000 = $50,000 FV of Loan at the end of second year = 550,000(1+0.1) = $605,000 second payment = 605000 - 550000 = $55,000 FV of Loan at the end of third year = 605,000(1+0.1) = $665,500 third payment = 665500 - 605000 = $60,500 For Loan A loan_A = $500,000 Rate_A = 10% year simple interest first payment = 500,000 * r * t t = time = 1 year r = 0.1 first payment = 500,000*0.1*1 = $50,000 second payment = (500,000+50,000)*0.1*1 = $55,000 third payment = (500,000 + 50,000 + 55,000)*0.1*1 = $60,500 a) both the company pays same interest b)both interests on both loans are equal therefore there is no difference .

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