Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5 year, $6,000,000 bank loan to finance service equipment. The loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments. Sutton can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment?
Note: subtract the loan payment from the lease payment
enter "=PMT(10%,5,6000,0)" into excel withough quatation, or using a financial calculator would be fine. The answer would be the loan payment. subtract this from the lease payment you get 207 thousand and something
To calculate the difference between the bank loan payment and the lease payment, we need to calculate the payment amount for the bank loan first.
The bank loan is for $6,000,000 and has an interest rate of 10% amortized over 5 years with 5 end-of-year payments.
We can use the formula for calculating the payment amount of an amortized loan:
Payment = Loan Amount / Present Value Annuity Factor
To calculate the Present Value Annuity Factor, we can use the formula:
Present Value Annuity Factor = (1 - (1 + interest rate)^-n) / interest rate
Where n is the number of periods (in this case, 5).
Let's calculate the bank loan payment amount:
Present Value Annuity Factor = (1 - (1 + 0.10)^-5) / 0.10
= (1 - 1.61051) / 0.10
= 0.38949
Bank Loan Payment = $6,000,000 / 0.38949
= $15,397,320.04
Now, let's calculate the difference between the bank loan payment and the lease payment:
Difference = Lease Payment - Bank Loan Payment
= $1,790,000 - $15,397,320.04
= -$13,607,320.04
The bank loan payment is $13,607,320.04 smaller than the lease payment.
To find out how much larger or smaller the bank loan payment is compared to the lease payment, we need to calculate the annual payment for both options.
For the bank loan, we can use the formula for the amortization of a loan:
Loan Payment = Loan Amount / Present Value Factor
In this case, the loan amount is $6,000,000, and we need to calculate the present value factor.
The present value factor can be calculated using the following formula:
Present Value Factor = (1 - (1 / (1 + interest rate)^n)) / interest rate,
where "n" is the number of periods, which in this case is 5, and the interest rate is 10% or 0.10.
Using the formula, we can calculate the present value factor for the bank loan:
Present Value Factor = (1 - (1 / (1 + 0.10)^5)) / 0.10
Present Value Factor ≈ 3.79079
Now we can calculate the bank loan payment:
Bank Loan Payment = $6,000,000 / Present Value Factor
Bank Loan Payment ≈ $1,582,699.89
For the lease payment, we know that each end-of-year payment is $1,790,000, and there are 5 such payments.
Lease Payment = $1,790,000 × 5
Lease Payment = $8,950,000
Now we can calculate the difference between the bank loan payment and the lease payment:
Difference = Lease Payment - Bank Loan Payment
Difference = $8,950,000 - $1,582,699.89
Difference ≈ $7,367,300.11
Therefore, the bank loan payment is approximately $7,367,300.11 smaller than the lease payment.