INTRODUCTION TO

CORPORATE FINANCE
BBAF 309
ABUBAKAR MUSAH

1
 Loan Types & Repayment Plans
oWhenever a financial institution extend a credit (loan)
facility, provisions will be made for repayment of both
the principal and agreed interest over the agreed
period.
oThe three basic types of loans and their repayment
plans are:
oPure Discount loans
oInterest-only loans
oAmortized loans
 Pure Discount loans
oThis type of loan involves the borrower receiving money
now, but repays a single sum at future agreed period.
oSuppose you borrow GH¢1000 at 10% interest rate and to
pay a single sum at the end of the year, it becomes a pure
discount loan. The single sum will be
.
oSuppose as a credit officer of a bank, you agree to grant a
loan at 12% interest rate per annum for five years, which
requires the borrower to pay GH¢50,000 at the end of the
5th years. How much should you give?
 Interest-only loans
oThis type of loan requires the borrower to pay only
interest at each agreed interval period and repay the loan
amount (principal) at the end of the agreed future time.

oSuppose as credit officer of a bank, you agree to grant a

loan at 12% interest rate per annum for one year, which
requires the borrower to make interest payments every
month and to pay for the principal of GH¢50,000 at the
end of the year. Draw the monthly repayment schedule
for the borrower.
Month Total Pay. Principal Pay. Interest Pay. Outstanding Bal.
0 0 0 0 50,000
1 500 0 500 50,000
2 500 0 500 50,000
3 500 0 500 50,000
4 500 0 500 50,000
5 500 0 500 50,000
6 500 0 500 50,000
7 500 0 500 50,000
8 500 0 500 50,000
9 500 0 500 50,000
10 500 0 500 50,000
11 500 0 500 50,000
12 50500 50000 500 0
 Amortized Loans
oExcept for a few loans where a lump sum is taken with
interest, most loans are amortized.
oAmortization of a loan is a process where the interest and
part of the principal are paid periodically until the loan goes
to expiration.
oThe two most common methods are the fixed total payments
and the declining total payments
oThe fixed total payments are of two types- the flat (face-
value) method and the declining balance method.
 Amortized Loans
The flat method
oWith this method, the monthly principal and interest payments
are fixed, hence the total monthly payment is fixed.

oThe flat method calculates interest as a percentage of the initial

loan amount rather than the amount outstanding.

oThat is to say that, even though periodic payments reduces the

principal, interest is still calculated on the initial amount lent
out to the borrower.
 Amortized Loans
oSteps involved are:
1) Monthly principal payment (PP) = Principal (P)/number of
payments (n)

2) Monthly interest = P x monthly rate (r)

3) Total monthly payment = monthly principal +
monthly interest
4) Based on the calculations above a monthly payment
schedule is prepared for the entire period of the loan.
 Amortized Loans
Illustration
oA petty trader borrowed a sum of Ghc 1,000.00 from
GOGI’s microfinance for a period of 12 months at a rate of
20% p.a. As a loan officer of GOGI’s prepare a monthly
schedule for the customer using the flat method

Solution
oPrincipal(P) = 1,000
oInterest rate (r) = 20% p.a. = 1.67% per month.
oTerm/period of the loan = 1 year = 12 months
 Amortized Loans

The amortization schedule for a twelve month period is

presented in the next slide
Amortization Schedule for a 12 months Repayment Period Using the Flat Method.
Month Payments Principal Interest Outstanding balance
0 - - - 1,000.00
1 100 83.33 16.67 916.67
2 100 83.33 16.67 833.34
3 100 83.33 16.67 750.01
4 100 83.33 16.67 666.68
5 100 83.33 16.67 583.35
6 100 83.33 16.67 500.02
7 100 83.33 16.67 416.69
8 100 83.33 16.67 333.36
9 100 83.33 16.67 250.03
10 100 83.33 16.67 166.70
11 100 83.33 16.67 83.37
12 100 83.33 16.67 0.00
Total 1200 1,000.00 200.00 -
 Amortized Loans
The declining balance method
oThis method calculates interest as a percentage of the amount
outstanding over the loan term.

oInterest calculated on the declining balance means that interest

is charged only on the amount that the borrower still owes and
not the initial amount lent out.

oTo determine the fixed monthly payment, the present value of

ordinary annuity formula is used. This will then be split into
interest and principal payment
 Amortized Loans
oUsing the petty trader example, we prepare a loan repayment
schedule using the declining balance method as follows:
1) We first determine the fixed monthly payment using the present
value of ordinary annuity formula
Amortization Schedule for a 12 month Repayment Period Using the Declining Balance Method
Month Payments Principal Interest Outstanding balance
0 - - - 1,000.00
1 92.63 75.96 16.67 924.04
2 92.63 77.23 15.40 846.79
3 92.63 78.52 14.21 768.29
4 92.63 79.83 12.81 688.46
5 92.63 81.16 11.48 607.30
6 92.63 82.51 10.12 524.79
7 92.63 83.88 8.75 440.91
8 92.63 85.28 7.35 355.63
9 92.63 86.70 5.93 268.93
10 92.63 88.15 4.49 180.78
11 92.63 89.62 3.02 91.16
12 92.63 91.16 1.53 0.00
Total 1,111.56 1,000.00 111.76 -
 Amortized Loans
oAdvantages of the flat method
 It is easy to calculate
 Exactly half of the amount is paid at the mid point of the
loan term.
oAdvantages of the declining balance method
 Interest is charged on the amount outstanding
 In the end, lower interest rate is paid compared to the flat
method.
 Amortized Loans
The Declining Total Payment Method
oThis method calculates interest as a percentage of the amount
outstanding over the loan term. Principal payments are however
fixed over the loan period.
oInterest calculated on the declining balance means that interest
is charged only on the amount that the borrower still owes and
not the initial amount lent out.
oTo determine the monthly payment, monthly interest on the
remaining principal balance is determined and added to the
fixed monthly principal payments
 Amortized Loans
oThe steps involved are
1) Determine the fixed monthly principal payment

2) Calculate the interest for each period on principal for each

period and add to the fixed monthly principal payment to
determine the total payment for that period
o1st month:
 Amortized Loans
o2nd month:

oIt goes on and on until payment for the last month is

made. This will be discussed further in class. The
Amortization Schedule: 12 Month Repayment Period (Declining Total Payment Method)
Month Payments Principal Interest Outstanding balance
0.00 - - - 1000.00
1.00 100.00 83.33 16.67 916.67
2.00 98.61 83.33 15.28 833.33
3.00 97.23 83.33 13.89 750.00
4.00 95.84 83.33 12.50 666.67
5.00 94.45 83.33 11.11 583.33
6.00 93.06 83.33 9.72 500.00
7.00 91.67 83.33 8.34 416.67
8.00 90.28 83.33 6.95 333.33
9.00 88.89 83.33 5.56 250.00
10.00 87.50 83.33 4.17 166.67
11.00 86.11 83.33 2.78 83.33
12.00 84.72 83.33 1.39 0.00
Total 1108.36 1000.00 108.36 -
 CLASS EXERCISE

SOBOLO Company Ltd, producers of Sobolo and Burkina,

have take a loan of ¢1,200 at an annual interest rate of 36%
from ACBF Bank Ltd, a company you work for as a credit
officer. The loan term is 12 months.
Required
Prepare a monthly amortization schedule for SOBOLO
Company Ltd using:
a. The flat method
b. The declining balance method
c. The declining total payments method