3. Smart Loan

How long would it take for S&S Air to pay off the smart loan assuming 30-year traditional mortgage payments? Hint: The payment for a loan repaid with equal payments is the annuity payment with the loan value as the PV of the annuity.

Why is this shorter than the time needed to pay off the traditional mortgage? Hint: The bi-weekly payments pay off the loan quicker for two reasons. Ask yourself, when does the payment get to the bank? Ask yourself, how many full payments is the company making each year?

How much interest would the company save? Hint: First figure the difference. Then note this calculation is very misleading. This is actually a pseudo interest savings, which is caused by the different maturities of the loans. If the actual interest rate is 6.1 percent, the present value of the two cash flows is still $35 million. More interest accrues in the 30-year traditional mortgage because of the longer length, but the present value is still the same as the present value of the bi-weekly mortgage, so the two mortgage cash flow streams are equivalent. To actually figure out the answer you must calculate the EAR of each of the loans. Do this for your answer. Give the 2 EARs for your answer.

EAR monthly:

EAR bi-weekly:

4. Assume S&S Air takes out a bullet loan under the terms described. What are the payments on the loan? Hint: The loan payments for the first 59 months are the same as the traditional 30-year mortgage. This mortgage payment will be made in the 60th month as well, but the company will also make the bullet payment. The bullet payment can be found by using an amortization table, but the easier method is to find the present value of the remaining loan payments.

Monthly payments 1-59:

Bullet Payment, 60^th month. (Show your work to calculate bullet payment):

5. What are the payments for the interest-only loan? Hint: The interest-only loan requires only interest payments each month. Calculate it. The company will make these payments for the first 119 months, and then repay the principal and interest on the 120th payment. So, the 120th payment must be calculated.

Monthly interest payments 1-119:

Final payment, 120th payment:

6. Which mortgage is the best for the company? Are there any potential risks in this action? Hint: Answer which has the lowest rate. One way to show loan is the better option is to consider what happens if the company makes the same payments on the interest only loan as it would if took out the traditional 30-year mortgage. If the company makes these payments, how long would it take to pay off the interest-only loan.

CHAPTER CASE S&S AIR'S MORTGAGE ark Sexton and Todd Story, the owners of S&S Air, Inc., were impressed b e work Chris had done on financial planning. Using Chris analysis, and looking at the demand for light aircraft, they have decided that their existing fabrication equipment is sufficient, but it is time to acquire a bigger manufacturing facility. Mark and Todd have identified a suitable structure that is currently for sale, and they believe they can buy Manalysis, and lonam or igh aircenat, they have decided that their existing fabrication equipment is but i is time te and refurbish it for about $35 million. Mark, Todd, and Chris are now ready to meet with Christie Vaughan, the loan officer for First United Nation Bank. The meeting is to discuss the mortgage options available to the company to finance the new facility Christie begins the meeting by discussing a 30-year mortgage. The loan would be repaid in equal monthly installments. Because of the previous relationship between S&S Air and the bank, there would be no closing costs for the loan. Christie states that the APR of the loan would be 6.1 percent. Todd asks if a shorter mortgage loan is available. Christie says that the bank does have a 20-year mortgage available at the same APR. works as follows: Every two weeks a mortgage payment is made that is head. He then states this is the best mortgage option available to the company since it saves interest payments prompting, she goes on to explain a bullet loan. The monthly payments o Mark decides to ask Christie about a "smart loan" he discussed with a mortgage broker when he was refinancing his home loan. A smart loan xactly one-half of the traditional monthly mortgage payment. Christie informs him that the bank does have smart loans. The APR of the smart loan would be the same as the APR of the traditional loan. Mark nods hi Christie agrees with Mark, but then suggests that a bullet loan, or balloon payment, would result in the greatest interest savings. At Todd's bullet loan would be calculated using a 30-year traditional mortgage. In would make the mortgage payments for the traditional 30-year mortgage for the first five years, but immediately after the company makes the 60th payment, the bullet payment would be due. The bullet payment is the remaining principal of the loan. Chris then asks how the bullet payment is calculated. Christie tells him that the remaining principal can be this case, there would be a 5-year bullet. This would mean that the co mpany would nm calculated using an amortization table, but it is also the present value of the remaining 25 years of mortgage payments for the 30-year mortgage. Todd has also heard of an interest-only loan and asks if this loan is available and what the terms would be. Christie says that the bank offers an interest-only loan with a term of 10 years and an APR of 3.5 percent. She goes on to further explain the terms. The company would be responsible for making interest payments each month on the amount borrowed. No principal payments are required. At the end of the 10-year term, the company would repay the $35 million. However, the company can make principal payments at any time. The principal payments would work just like those a traditional mortgage. Principal payments would reduce the principal of the loan and reduce the interest due on the next payment. ark and Todd are satisfied with Christie's answers, but they are still unsure of which loan they should choose. They have asked Chris to answer the following questions to help them choose the correct mortgage