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Problem 8.17 United Arab Emirates Small Business Loan (A) Mohammad tried one last time to explain the loan structure offered by the companys UAE bank.
| Problem 8.17 United Arab Emirates Small Business Loan (A) | |||||||||
| Mohammad tried one last time to explain the loan structure offered by the companys UAE bank. His boss just stared at him. Mo explained the detailed calculation of annual interest and principal payments, step-by-step, as detailed by the bank. | |||||||||
| The loan was for USD5 million, for five years, with an 8.200% interest rate. | |||||||||
| Step 1: Calculate interest on Loan Principal for one year | |||||||||
| Step 2: Multiply that interest by the number of years of the loan. The bank labeled this "Total Interest." | |||||||||
| Step 3: Add the calculated Total Interest to the Loan Principal. | |||||||||
| Step 4: Divide this calculated total by the number of years of the loan. This is the annual payment due on the loan (principal and interest). | |||||||||
| Step 5: Using the calculated annual payment from step 4, structure the repayments to maake all interest payments (totaling to Total Interest from Step 2) up-front. Once all interest has been paid, the remaining cash flows associated with the annual payment are considered repayment of principal. | |||||||||
| a. Following the 5 steps described, lay out the principal and interest payments on the loan agreement. | |||||||||
| b.Calculate effective cost of funds on the loan agreement (the all-in-cost). | |||||||||
| c. Lay out the principal and interest payments on the same loan if it was a 'normal' amortizing loan. | |||||||||
| d. What is your assessment of the loan? | |||||||||
| a. The loan calculations would appear as follows. | |||||||||
| Loan | 0 | ||||||||
| Loan Principal | $ 5,000,000.00 | ||||||||
| Interest rate | 8.2000% | ||||||||
| Maturity (years) | 5.0 | ||||||||
| Step 1. Calculate interest on principal for one year. | |||||||||
| Interest rate x Loan Principal | |||||||||
| Step 2. Multiply that interest by the number of years of the loan. This is "Total Interest." | |||||||||
| Total Interest = Interest x 5 | |||||||||
| Step 3. Add the calculated Total Interest to the Loan Principal. | |||||||||
| Total Interest + Loan Principal | |||||||||
| Step 4: Divide this calculated total by the number of years of the loan. This is the annual payment due on the loan (principal and interest). | |||||||||
| Interest (total) payment in year 1 | |||||||||
| Step 5: Using the calculated annual payment from step 4, structure the repayments to make all interest payments (totaling to Total Interest from Step 2) up-front. Once Total Interest has been repaid, the balance on the annual payments are to be considered repayment of principal. | |||||||||
| a. The principal and interest payments on the loan structure described. | |||||||||
| Payments | 0 | 1 | 2 | 3 | 4 | 5 | |||
| Funds raised | |||||||||
| Interest payment | |||||||||
| Principal payment | |||||||||
| Total cash flows | |||||||||
| b. The effective cost of funds, the all-in-cost (AIC) on the loan, is found by finding the IRR of the cash flow series. | |||||||||
| AIC (IRR) | |||||||||
| c. If the same loan was structured as a normal amortizing loan: | |||||||||
| Payments | 0 | 1 | 2 | 3 | 4 | 5 | |||
| Funds raised | |||||||||
| Interest payment | |||||||||
| Principal payment | |||||||||
| Total cash flows | |||||||||
| AIC (IRR) | |||||||||
| d. What is your assessment of the loan? | |||||||||
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International Financial Reporting A Practical Guide
Authors: Alan Melville
6th edition
1292200743, 1292200766, 9781292200767, 978-1292200743
