You have applied for a $1 million equipment loan from your bank. The loan repaym
ID: 2737564 • Letter: Y
Question
You have applied for a $1 million equipment loan from your bank. The loan repayment will consist of five equal payments at the end of each of the next five years, with each payment being part interest and part principal. The bank has agreed to loan you the money over a five-year period at an 8% rate of interest if you (1) pay a loan origination fee of $25,000; (2) pay bank fees of $24,000 per year; and (3) pay the legal fees of $5,000 to have a clear title to the equipment at the end of the loan period. What is the effective rate of interest on this loan?
Explanation / Answer
LOAN PAYMENT PER YEAR
= $1000000 / PVIFA 8%, 5 PERIODS
= $1000000 / 3.9927
= $250457
CASH FLOW OF YEAR 0
= $1000000 - $25000
= $975000
CASH FLOW OF YEAR 1 - 4
= -$250457 - $24000
= -$274457
CASH FLOW OF YEAR 5
= -$250457 - $24000 - $5000
= -$279457
BY USEING EXCEL FUNCTION IRR OF THE ABOVE CASH FLOW IS 12.71%
SO THE EFFECTIVE INTEREST RATE IS 12.71%
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