11. Bank loans Aa Aa Short-term financing through bank loans Consider this case:
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Question
11. Bank loans Aa Aa Short-term financing through bank loans Consider this case: Central Corp. needs to take out a one-year bank loan of $600,000 and has been offered loan terms by two different banks, one bank has offered a simple interest loan of 12% that requires monthly payments. The loan principal will be paid back at the end of the year. Another bank has offered 9% add-on interest to be repaid in 12 equal monthly installments. Based on a 360-day year, what will be the monthly payment for each loan for November? (Hint: Remember that November has 30 days.) Value Simple interest monthly payment Add-on interest monthly payment Choose the answer that best evaluates the following statement: Zebra Engineering Corp. always prefers simple interest loans over add-on interest loans because even if the interest rate is higher on the simple interest loan, its monthly payment is lower. O The company should only accept add-on interest loans when it cannot get simple interest loans. O The company needs to be sensitive to interest rate differences between loan types and take them into consideration when deciding what type of loan to take out.Explanation / Answer
Simple interest monthly payment for november = 600,000*0.12*30/360 = $ 6,000. The principal will be paid off in full in dec end.
Add on interest monthly payment calculation method:
Interest = 600,000*0.09*1= 54,000
Principal + interest = 600,000+54,000= 654,000
Monthly payment = 654,000/12 = $ 54,500
So, november monthly payment for add on interest method will be = $ 54,500
The effective interest rate in Add on method will always be more than simple interest method because although in add on method we pay off some principal amount along with interest in EMI but we are always charged interest on the original loan amount. But in simple interest method principal is paid off in last as per question.
So, for the second part the company should only accept add on interest loans only when it cannot get simple interest loans.
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