Pare Co. borrowed $80,000 from National Bank by issuing a note with a five-year term. Pare has two options with respect to the payment of interest and principal. Option 1 requires the payment of interest only on an annual basis with the full amount of the principal due at maturity.
Option 2 calls for an annual payment that includes interest due plus a partial repayment of the principal balance. The effective annual interest rate on both notes is identical.
Required
Write a memo explaining how the two alternatives will affect
(a) The carrying value of liabilities,
(b) The amount of annual interest expense,
(c) The total amount of interest that will be paid over the life of the note, and
(d) The cash flow consequences.