Q1

BioTech has decided to finance the project with initial investment of $50,000 through debt
financing. The bank has offered loan at 9% interest for a period of 5 years based on 3 different
repayment methods. Recommend which method of debt financing is most cost effective and
explain why. Support your recommendation with relevant workings.

(a) All principal and compound interest are paid back on the 5th year. Show the loan
amortization table.

FV = 50,000 X ( 1+ r )n

= 50,000 x ( 1 + 0.09 )5

= 50,000 x 1.53862

=$76931.20

Interest paid = Total payment - Loan amount

Interest paid = 76,931.20 - 50,000 = $26,931.20

Year Open bal Interest Payment Closing bal

1 50000 4500 0 54500

2 54500 4905 0 59405

3 59405 5346.45 0 64751.45

4 64751.45 5827.63 0 70579.08

5 70579.08 6352.12 76931.20 0

Total interest 26931.20

(8 marks)

(b) Interest are paid yearly with principal paid at end of the 5th year. Show the loan
amortization table.
Annual Interest Payment (Years 1-4) = 50,000 x 0.09 x 4 =18000
Year 5 payment= Annual interest payment + Principal payment
Year 5 payment = 4,500 + 50,000 = 54,500
Total payment = 18000+ 54,500 = 72500
Interest paid = 22,500
Year Open bal Interest Payment Closing bal
1 50,000 4500 4500 50000

2 50,000 4500 4500 50000

3 50,000 4500 4500 50000

4 50,000 4500 4500 50000

5 50,000 4500 54500 0

Interest 22,500

(8 marks)

(c) Pay 5 equal payments at each year inclusive of interest and principal. Show the loan
amortization table.

PMT = 12854.62
Total payment = 5 x 12854.62 = 64273.10
Interest paid = Total Payments - Loan Amount
Interest paid = 64273.10-50,000 = 14273.10

Year Open bal Interest Payment Closing bal

1 50,000 4500 12854.62 41645.38

2 41645.38 3748.08 12854.62 32538.84

3 32538.84 2928.50 12854.62 22612.72

4 22612.72 2035.14 12854.62 11793.24

5 11793.24 1061.40 12854.62 0

Total interest 14273.12

Beginning Annual Interest Principle paid Ending

balance payment balance
 50,000 12854.62 4500 8354.62 41645.38

41645.38 12854.62 3748.08 9106.54 32538.84

32538.84 12854.62 2928.50 9926.12 22612.72

22612.72 12854.62 2035.14 10819.48 11793.24

11793.24 12854.62 1061.40 11793.22 -0.01

(8 marks)
(d) Recommend which method of debt financing is most cost effective and explain why.

● The amortized loan is the one with the lowest interest expense since it requires a
higher annual payment, part of which reduces the unpaid balance on the loan and
thus results in less interest being charged over the 5-year term