Chez Quis Inc. needs to take o

Chez Quis Inc. needs to take out a one-year bank loan of $500,000 and has been offered loan terms by two different banks. One bank has offered a simple interest loan of 9% that requires monthly payments. The loan principal will be paid back at the end of the year. Another bank has offered 6% add-on interest to be repaid in 12 equal monthly installments.

5. Bank loans

Short-term financing through bank loans

Consider this case:

Chez Quis Inc. needs to take out a one-year bank loan of $500,000 and has been offered loan terms by two different banks. One bank has offered a simple interest loan of 9% that requires monthly payments. The loan principal will be paid back at the end of the year. Another bank has offered 6% add-on interest to be repaid in 12 equal monthly installments.

Based on a 360-day year, what will be the monthly payment for each loan for November? (Hint: Remember that November has 30 days.)

Value

Simple interest monthly payment
Add-on interest monthly payment

Choose the answer that best evaluates the following statement:

A bank loan officer has been approached by a start-up company that needs a five-year loan to purchase the equipment for its first project. The project will have a life of five years. At the end of five years, the equipment will be worthless. The founders of the company told the loan officer that they would be willing to pay a much higher interest rate on a simple interest loan rather than contracting to an add-on interest loan.

a) The loan officer should offer the company an add-on interest loan because there is a high risk that the company will not be able to repay the principal on the loan at the end of the project’s life.

b) The loan officer should offer the company a simple interest loan. The bank will make more money in the long run, because it can charge a much higher interest rate.

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