Companies frequently borrow money under an arrangement that requires them to mak

Question

Companies frequently borrow money under an arrangement that requires them to make periodic payments of only interest and then pay the principal of the loan all at once. A company that manufactures odour control chemicals borrowed $400,000 for 3 years at 10% per year compound interest under such an arrangement. What is the difference in the total amount paid between this arrangement (Plan 1) and Plan 2, in which the company makes no interest payments until the loan is due and then pays it off in one lump sum?

Explanation / Answer

plan 1 let fixed amount be X   

400000 = X/.1 *(1-1/1.1^3) +400000 /1.1^3 IMPLIES X = 40000 IMPLIES 3X = 120000 TOTAL AMOUNT PAID IN PLAN1 = 520000

PLAN 2 COMPANY PAYS 400000 *(1.1)^3 =532400

DIFFERENCE = -124000

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