Dodson Co. is planning to finance an expansion of its operations by borrowing $120,000. City Bank...

Question:

Dodson Co. is planning to finance an expansion of its operations by borrowing $120,000. City Bank has agreed to loan Dodson the funds. Dodson has two repayment options:

(1) to issue a note with the principal due in 10 years and with interest payable annually or

(2) to issue a note to repay $12,000 of the principal each year along with the annual interest based on the unpaid principal balance.

Assume the interest rate is 8 per cent for each option.

a) What amount of interest will Dodson pay in year 1?

i) Under Option 1

ii) Under Option 2

b) What amount of interest will Dodson pay in year 2?

i) Under Option 1

ii) Under Option 2

Interest

Interest is in simple words is the price of money, higher the demand of money in the economy, higher will be the interest rates, the rational behind interest is, if a person is lending his or her money then he will demand some extra money as a compensation, this compensation is known as interest.

Answer and Explanation:

In option 1, interest will be same for both year

Part a)

Interest for year 1

i) In option 1 = 120000 * .08 = $9600

ii) In option 2 = 120000 * .08 =$9600


Interest for 2nd year

i) in option 1 = 120000 * .08 = $9600

ii) in option 2 = (120000 -12000) * .08=$8640


Learn more about this topic:

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How to Calculate Interest Expense: Formula & Example

from Financial Accounting: Help and Review

Chapter 5 / Lesson 18
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