Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is $150,000. The company can borrow $150,000 for three years at 10 percent annual interest or for one year at 8 percent annual interest.
1) How much would Sauer Food Company save in interest over the three-year life of the computer system if the one-year loan is utilized and the loan is rolled over (reborrowed) each year at the same 8 percent rate?
2)Compare this to the 10 percent three-year loan. What if interest rates on the 8 percent loan go up to 13 percent in year 2 and 18 percent in year 3?
3) What would be the total interest cost compared to the 10 percent, three-year loan?
Sauer Food Company is faced with the decision of acquiring a new computer system, which has an expected useful life of three years. This purchase comes at a cost of $150,000. To finance this investment, the company has two loan options: a one-year loan at an 8 percent annual interest rate or a three-year loan at a 10 percent annual interest rate. In this essay, we will explore the financial implications of each financing option, taking into account the possibility of the interest rates on the one-year loan changing in the second and third years.
Sauer Food Company can choose to utilize the one-year loan and then roll it over (reborrow) at the same 8 percent rate each year for three years. Let’s calculate the total interest cost over this period:
Year 1: Interest = Principal x Rate = $150,000 x 8% = $12,000
Year 2: Interest = Principal x Rate = $150,000 x 8% = $12,000
Year 3: Interest = Principal x Rate = $150,000 x 8% = $12,000
Total Interest Cost = $12,000 (Year 1) + $12,000 (Year 2) + $12,000 (Year 3) = $36,000
Now, let’s compare this to the alternative financing option, the 10 percent three-year loan.
Total Interest Cost for the 10 Percent Three-Year Loan: Interest = Principal x Rate = $150,000 x 10% = $15,000 (Year 1) Interest = Principal x Rate = $150,000 x 10% = $15,000 (Year 2) Interest = Principal x Rate = $150,000 x 10% = $15,000 (Year 3)
Total Interest Cost = $15,000 (Year 1) + $15,000 (Year 2) + $15,000 (Year 3) = $45,000
Clearly, by opting for the one-year loan and rolling it over, Sauer Food Company saves a significant amount in interest expenses compared to the three-year loan at 10 percent.
Now, let’s consider the scenario where the interest rates on the one-year loan increase to 13 percent in year 2 and 18 percent in year 3.
Year 1: Interest = Principal x Rate = $150,000 x 8% = $12,000
Year 2: Interest = Principal x Rate = $150,000 x 13% = $19,500
Year 3: Interest = Principal x Rate = $150,000 x 18% = $27,000
Total Interest Cost = $12,000 (Year 1) + $19,500 (Year 2) + $27,000 (Year 3) = $58,500
The total interest cost with the changing interest rates on the one-year loan is $58,500, while the three-year loan at 10 percent costs $45,000. In this scenario, the three-year loan becomes the more cost-effective option.
Sauer Food Company should carefully evaluate its financing options for acquiring the new computer system. If the interest rates on the one-year loan remain constant at 8 percent for all three years, it offers significant interest savings over the three-year loan at 10 percent. However, if interest rates on the one-year loan increase as described in the scenario, the three-year loan at 10 percent becomes the more cost-effective choice. Therefore, the company’s decision should consider both the current interest rate environment and potential future rate fluctuations to make an informed financial choice that aligns with its long-term financial goals.
As a renowned provider of the best writing services, we have selected unique features which we offer to our customers as their guarantees that will make your user experience stress-free.
Unlike other companies, our money-back guarantee ensures the safety of our customers' money. For whatever reason, the customer may request a refund; our support team assesses the ground on which the refund is requested and processes it instantly. However, our customers are lucky as they have the least chances to experience this as we are always prepared to serve you with the best.
Plagiarism is the worst academic offense that is highly punishable by all educational institutions. It's for this reason that Peachy Tutors does not condone any plagiarism. We use advanced plagiarism detection software that ensures there are no chances of similarity on your papers.
Sometimes your professor may be a little bit stubborn and needs some changes made on your paper, or you might need some customization done. All at your service, we will work on your revision till you are satisfied with the quality of work. All for Free!
We take our client's confidentiality as our highest priority; thus, we never share our client's information with third parties. Our company uses the standard encryption technology to store data and only uses trusted payment gateways.
Anytime you order your paper with us, be assured of the paper quality. Our tutors are highly skilled in researching and writing quality content that is relevant to the paper instructions and presented professionally. This makes us the best in the industry as our tutors can handle any type of paper despite its complexity.
Recent Comments