Alvin wishes to borrow 5000 Lender X offers a loan in which

Alvin wishes to borrow $5000. Lender X offers a loan in which the principal is to be repaid at the end of ten years. In the meantime 10% effective is to be paid annually on the loan and Alvin is to accumulate the amount necessary to repay the loan by means of annual deposits in a sinking fund earning 8% effective. Lender Y offers a loan for ten years in which Alvin repays the loan by the amortization method.

A) If Alvin borrows from Lender X, what will his total annual outlay be?

B) What is the largest effective rate of interest that Lender Y can charge so that Alvin is indifferent between the two offers?

Solution

A) Alvin has to pay 10% of $5000 which is equal to $500

b) According to amortization method he can maximum charge him 8% so that there is no loss for Alvin