AMORTISATION AND SINKING FUNDS

- A loan is said to be amortised when all liabilities (principal +

interest ) are paid by a sequence of equal payments made at equal
intervals of time.

QN A LOAN OF $10000 WITH INTEREST OF 14% COMPOUNDED

QUARTERLY IS TO BE ARMORTISED BY EQUAL QUARTERLY
PAYMENTS OVER 5 YEARS AND THE FIRST PAYMENT IS DUE AT
THE END OF ITS FIRST QUARTER. CALCULATE THE PAYMENT
(INSTALLMENTS)

CF = (PV * r) / [1-(1/(1+r)^n))]

CF=(350)/[1-0.502565884]
CF = $703.6

QN DRAW UP AN ARMOTISATION TABLE OR SCHEDULE OF A

LOAN $5000 THAT IS BEING PAID IN ANNUAL INSTALMENTS
OVER 5 YEARS AT AN INTEREST RATE OF 15% PER ANNUM.
1st step calculate the payments to be made in equal instalments as above
=$1491, 58
2nd step Outstanding Principal at the beginning less principal prepaid
3rd step calculate interest due at the end of each year eg for 1st year
15%*5000 = 750
2nd year
15%*4258,42= 638,72
4th step calculate principal prepaid = payment –interest at the end of year
eg 1st year = 1491,58- 750
SCHEDULE WILL BE AS FOLLOWS
YEAR OUTSTANDING INTEREST PAYMENTS PRINCIPAL
PRINCIPAL DUE PAID
AT THE @ END OF
BEGINNING OF THE YEAR
THE YEAR
1 5000 750 1491,58 741,58
2 4258,42 638,76 1491,58 852,82
3 3405,60 510,84 1491,58 980,74
4 2424,86 363,73 1491,58 1127,85
5 *1297,01 194,55 1491,58 *1297,02
STEP 2 3 1 4
S

NB at the end the outstanding amount will be the same as the loan balance
SINKING FUNDS
It is the savings account used to accumulate the capital needed to payback
the principal value of a loan at the end of a term
It can also be created for the replacement of a non current asset.
Interest is paid at the end of every period and a separate account to
accumulate principal amount is created
In most cases the interest on the sinking fund is different from that of a
debt.
QN A DEBT OF $10000 BEARING INTEREST OF 14% PER ANNUM
IS TO BEE PAID SEMI ANNUALLY AND IS TO BE DISCHARGED BY
A SINKING FUND METHOD. IF THE FUNDS EARNS INTEREST AT
THE RATE OF 12% PER ANNUM COMPOUNDED QUARTERLY AND
A DEBT IS DISCHARGED AFTER 5 YEARS.
DETERMINE THE SIZE OF THE QUARTERLY DEPOSIT
CALCULATE THE TOTAL YEARLY COST OF DEBT
SOLUTION:
Use the formula
CF = (PV * r) / [1-(1/(1+r)^n))]
Size of the quarterly deposit will be 300/0,446324246 = $672,16
Total yearly cost of debt will be :
$672,16 * 4 times a year = 2688,64
$10 000 *(0,14/2)*2 =1400
Total = (2688, 64 +1400) = 4088,64

PRACTICE QUESTIONS
QN 1 A COMPANY BORROW 20000 FOR 6YRS @ 16% PER ANNUM
COMPOUNDED QUARTERLY. INORDER TO PAY OFF THE DEBT
AT THE END OF 6YRS, IT ESTABLISHED A SINK FUND BY
MAKING EQUAL ANNUAL PAYMENTS AT THE END OF EACH
YEAR INTO A SAVINGS ACCOUNT PAYING 12% PER ANNUM
COMPOUNDED ANNUALLY
DETERMINE THE YEARLY DEPOSIT INTO THE FUND
CALCULATE THE TOTAL ANNUM COST OF SERVICING THE
DEBT

ALL THE BEST