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164 PART 3 Valuation of Future Cash Flows CHAPTER CASE S&S Air's Mortgage M ark Sexton and Todd Story, the owners of SRS Airine I were impressed by the work Chris had done on finan- cial planning. Using Chris's analysis and inline at the mand for light aircraft, they have decided that their existing on equipment is sufficient, but it is time to acquire a bigger manufacturing facility Mark and Todd hendent ned a suitable structure that is currently for sale, and they believe they can buy 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 National 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 be- tween 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 mort gage loan is available. Christie says that the bank does have a 20-year mortgage available at the same APR. Mark decides to ask Christie about a 'smart loan" he discussed with a mortgage broker when he was refl- nancing his home loan. A smart loan works as follows: Every two weeks a mortgage payment is made that is exactly one-half of the traditional monthly mortgage pay ment. 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 his head. He then states this is the best mortgage option available to the company because it saves interest payments. Christie agrees with Mark, but then suggests that a bullet loan, or balloon payment, would result in the At Todd's prompting, she createst interest savings. At 10 The monthly payments of on to explain a bullet loon. hill loan would be calculated using a 30-year tran case, there would be a 5. tional mortgage. In this case bullet. This means that the company would make m ortgage payments for the traditional 30-year morta for the first five years, but immediately after the com pany makes the 60th payment, the bullet paymer would be due. The bullet payment is the remaining biri cipal of the loan. Chris then asks how the bullet payme is calculated. Christie tells him that the remaining prin pal can be calculated using an amortization table, but is also the present value of the remaining 25 years of mortgage payments for the 30-year mortgage. Todd also has heard of an interest-only loan asks if this loan is available and what the terms would be. Christie says that the bank offers an interest-onh 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 pa ments 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 on a trad tional mortgage. Principal payments would reduce the principal of the loan and reduce the interest due on the next payment. Mark and Todd are satisfied with Christie's answers but they are still unsure of which loan they should choose. They have asked Christo answer the following questions to help them choose the correct mortgage QUESTIONS 1 What are the monthly payments for a 30-year traditional mortgage? What are the payments for a 20 year traditional mortgage? 2. Prepare an amortization table for the first six months of the traditional 30-year mortgage. How much of the first payment goes toward principal? 3. How long would take for S&S Air to pay off the smart loan assuming 30 year traditional mortgage payments? Why is this shorter than the time needed to pay off the traditional mortgage? How much interest would the company save? 4. Assume S&S Air takes out a bullet loan under the terms described. What are the payments on the loan? 5. What are the payments for the interest-only loan? 6. Which mortgage is the best for the company Are there any potential risks in this action