The ABD Company has decided to switch some debt to its newes

The ABD Company has decided to switch some debt to its newest division, DEMO, in order to show a more hansom corpordte profit. The original amount of the debt to be transferred is $286,400. This amount comes due on a balloon note (single payment) on July 1,1998. The original debt carried a l 1% interest rate for three (3) years which matures on July 1, 1998. The ABD Company has required DEMO to repay the entire debt in five (5) years. Although, the interest rate for a new company is 95% DEMO\'s president says he has a \"hook-up\" at his \"boys\" bank that will give the division an 8% rate (compounded monthly). ABD has required DEMO not to exceed S500,000 per year cash flow (total cash putlay for the year), excluding salaries and other related personnel cost. You are the new engineer on the block, therefore, you are to do the engineering economic analysis for this situation. Analyze the repayment of the debt by using the four (4) standard repayment plans for the \"hook-up\" rate. Then evaluate the equivalence using the same plans at the expected interest rate for a new company. NOTE: All work should be on engineering paper and in the report form established in technical report writing. If you can not letter in the manner presented in engineering graphics, you must type the report. NOTE: Clone scores will be divided equally. IH you are declared a clone neither your score, your report, or you being a clone is open to discussion. Any student insisting upon discussion of a clone score will be penalized an additional 100 pts.

Solution

Under the hook up rate, DEMO division shall have to pay $ 286,400 in five years

Under standard repayment plan, DEMO division shall have to make monthly repayments for loan of $286,400 at 8.00% interest compounded monthly for 60 months.

Monthly Payment can be calculated in MS Excel using PMT function as follows:-

=PMT(0.08/12,60,-286400,,) which shall provide monthly payment of $ 5,807.16.

Prevailing interest rates for loan to new companies is 9.5%.

If loan is taken at 9.5% for $ 286,400, payment of $ 422,440 (286,400 + 286,400 X 9.5% X 5) shall have to be made at the end of five years.

Present value of $ 422,440 to be made after five years shall be $ 268,345.58 (422,440 X 1/(1.095)^5)

Whereas present value of $ 5,807.16 to be paid in 60 instalments can be calculated as below:-

=PV(0.095/12,60,5807.16,,) which shall present value of $ 276,506.89

Hence, raising loan at 9.5% is more profitable than raising loan at 8.00% compounded monthly.