Question

Big T Burgers and Fries Corp. needs to take out a one-year bank loan of $500,000 and has been offered loan terms by two different banks. One bank has offered a simple interest loan of 10% that requires monthly payments. The loan principal will be paid back at the end of the year. Another bank has offered 7% add-on interest to be repaid in 12 equal monthly installments.

Answer 1

One bank has offered a simple interest loan of 10% that requires monthly payments. The loan principal will be paid back at the end of the year.

to calculate the monthly payment we must use the present value of an annuity formula:

monthly payment = principal / ({1 - [1 / (1 + r)ⁿ]} / r)

monthly payment = $500,000 / ({1 - [1 / (1 + 0.008333)¹²]} / 0.008333) = $43,957.94

THIS OPTION IS BETTER BECAUSE MONTHLY PAYMENTS ARE LOWER

Another bank has offered 7% add-on interest to be repaid in 12 equal monthly installments.

amount of principal paid per month = $500,000 / 12 = $41,666.67

amount of interest paid per month = ($500,000 x 7%) / 12 = $2,916.67

total monthly payment = $44,583.34