Loan interest rates

FIG. 9-37 Effect of loan interest rate on the net present value of a project. 

Providers also offer an assortment of bundled benefits such as waiving the annual fee for credit cards, offering preferential commercial or mortgage loan interest rates, free online banking membership, lower insurance premi-... 

Integrated plants provide investment incentives associated with cash grants, loan interest rate subsidies, leasing subsidies, tax allowances, etc. These incentives may contribute decisively in increasing the competence of the pulping itself. 

In the above example, the discount rate used was the annual compound interest rate offered by the bank. In business investment opportunities the appropriate discount rate is the cost of capital to the company. This may be calculated in different ways, but should always reflect how much it costs the oil company to borrow the money which it uses to invest in its projects. This may be a weighted average of the cost of the share capital and loan capital of a company. 

Another instance of differential inflation occurs when the prices of goods and services rise uniformly but the cost of borrowing money, the interest rate charged on a loan, does not rise. 

If the fractional inflation rate is a fractional interest rate on a loan can be corrected to an effective rate of interest by Eq. (9-116) with ii substituted for (DCFRR). The effect of various amounts of loan, borrowed at various interest rates ii, on the net present value of a particular, fairly simple project is shown in Fig. 9-37. Thus, if 25,000 were borrowed at an interest rate of 15 percent for the project, the (NPV) would be about 43,000 at a zero inflation rate. But if the inflation for goods and services i, is 10 percent, the effective interest rate for that loan can be calculated from Eq. (9-116) to be only 4.55 percent. It is seen from Fig. 9-37 that this increases the (NPV) of the project to 48,000. This confirms the economic advantage of borrowing at a fixed interest rate in a time of general inflation. 

Interest. The interest for eaeh year must be calculated for the type of loan expected. The interest rate can be obtained from the company s financial section, recent loan history, or the literature. The Wall Street Journal publishes the weekly interest rates for several borrowings. The company s interest rate will probably be the banks prime rate, or slightly higher. 

Banks are not in business to take risks. They rent money and do everything they can to insure the return of their principal as well as the interest. Elaborate rating systems have been developed to measure each company s ability to repay its loans. One criterion is the debt to equity ratio. The higher the debt the more risk in a loan, and the higher the interest rate. 

The money used in a project must be returned by the project with interest whether it comes from debt or equity. The recent swings in the cost of money have brought to everyone s attention the complexity of setting return and interest rates for feasibility studies. If a project is ready to be built and the loans have been negotiated, the interest rate can be determined accurately. Establishing the interest rate for a feasibility study on a project that will not be built for one or more years in the future is difficult and becomes a policy decision that should be set by management. The same rate should be used on all studies to keep the yardstick the same length. 

The maximum amount your roommate would pay would be determined by his alternate sources of financing. If he could get a loan from a bank it would be at an interest rate of 8% or more. A loan from a finance agency would cost more. At 8% interest compounded annually 13,500 would be worth 23,100 after 7 years. To request that he pay you 23,100 on his twenty-fifth birthday in return for giving him 13,500 now would certainly be fair-especially if he let you use the car and if an ironclad Hen could be placed on his inheritance. 

Calculate the monthly and yearly payments for obtaining a loan of 30,000 that is to be fully repaid in 20 years. Assume an interest rate of 8%. 

Loans are usually money borrowed from financial institutions. The prime interest rate is the minimum interest rate that leading banks charge their most credit-worthy customers on large loans. In 1973 this reached a high of 10% per year (Table 10-12). When it was 7.5% per year one big chemical company was reported to be paying 10% interest per year. Usually 0.5-2% more than the prime interest rate is a reasonable value. 

One advantage to loans and bonds is that the interest paid can be deducted from profits before taxes are figured, whereas the dividend paid stockholders is an after-tax expense. In 1971 the income tax rate was 48% of all earnings. If the interest rate at that time was 10%, then after taxes it would equivalently be 5.2%. In other words, for each dollar spent on interest the profits would be reduced 1.00 and the... 

Since common stock (or equity) costs more than bonds, why do companies issue stock This is because a company is only able to borrow money at a good rate if the lender is 100% sure he can get his money back plus interest. The less sure he is that he can get his investment back, the higher the interest rate. When a bank is asked to finance the building of a private home it will rarely lend more than 85% of the cost of construction. It also insists that the house be insured, with the bank having the first lien. This means that in case of a catastrophe the bank loan is repaid first. Then the other creditors and the owners receive what is left. A lien s significance is that it takes precedence over all other debts. Even under this arrangement an individual is... 

If Ihe assets for the company whose balance sheet is given in Table 10-13 can only be sold at half their listed value, then after all the current liabilities and bonds have been paid off, there would be nothing left for the stockholders. In fact, some of the bondholders might not be totally reimbursed, since it would cost something to liquidate the company s assets. This company could not get a loan at prime interest rates. It would have a better chance of getting a good interest rate if its balance sheet resembled that given in Table 10-14. 

A finance company gives the following figures For a loan of 1,000 a person must make 36 monthly payments of 38.62 per month. What is the rate of return What is the nominal interest rate ... 

Banks and Financial Institutions high interest rates and difficulty getting loans for investment in social infrastructure are real constraints faced by exporters ... 

What is the present value of the tax savings on the annual interest payments if the loan payments consist of five equal monthly installments of principal and interest of 3600 on a loan of 120,000. The annual interest rate is 14.0%, and the tax rate is 40%. (Assume the loan starts at the first of July so that only five payments are made during the year on the first of each month starting August 1.)... 

Rachel borrows 12,000 for her new car at a simple interest rate of 3.5% for five years. What is the total amount Rachel will repay for this loan ... 

What is the simple interest rate on a 3,500.00 loan, taken out for 3 years, if the interest due after this time frame is 2,205.00 ... 

Example 6 Effective Interest Rate A person is quoted an 8.33 percent nominal interest rate on a 4-year loan compounded monthly Determine the effective interest rate. 

Cost of capital The cost of borrowing money from all sources, namely, loans, bonds, and preferred and common stock. It is expressed as an interest rate. 

Annual capital cost is for an interest rate of 2.8% over a 10-year loan. 

The cost of the company s own funds can thus be calculated, by means of the CAPM. However, it is an unusual company that does not have other sources of finance, each with its own cost (i.e. interest rates for different loans). The average cost of all of its sources of capital is expressed by a single figure, the weighted annual cost of capital ( WACC), calculated according to the relative amounts of each source of funds. 

In all cases of such borrowing, however, the company does not expect the interest to be paid by the project as it comes due, because the project has, as yet, no revenues from which to pay the interest. The lender will be paid its interest from other funds belonging to the company, and the interest due during construction is then turned into a capital sum (capitalised), which is then added to all of the other construction costs. The loan will normally be arranged at a fixed interest rate, so the extra sum can be calculated quite easily. 

But at the same time the regulation drafters are faced with the still more difficult job of doing a risk evaluation. That is, they must recommend public policy decisions as to the acceptable levels of risks for a variety of hazardous waste activities, e.g., acceptable minimums for the efficiency of destruction of hazardous wastes by incineration. In principle, this process may be not unlike the decisions made by a banker about a potential loan, or an insurance underwriter in setting the rate for an insurance policy a risk assessment is made, and an appropriate safety margin is factored into the interest rate or the policy premium to arrive at an acceptable level of risk for the individual case (but based on experience and projections for a large number of cases). 

The simplest form of interest requires compensation payment at a constant interest rate based only on the original principal. Thus, if 1000 were loaned for a total time of 4 years at a constant interest rate of 10 percent/year, the simple interest earned would be... 

Example 1 Applications of different types of interest. It is desired to borrow 1000 to meet a financial obligation. This money can be borrowed from a loan agency at a monthly interest rate of 2 percent. Determine the following ... 

One source of new capital is outside loans. Interest on such loans is usually at a fixed rate, and the annual cost can be determined directly. 

If the annual income-tax rate for a company is 34 percent, every dollar spent for interest on loans or bonds would have a true cost after taxes of only 66 cents. Thus, after income taxes are taken into consideration, a bond issued at an annual interest rate of 6 percent would actually have an interest rate of only 6 X = 4.0 percent. On the other hand, the dividends on preferred stock must be paid from net profits after taxes. If preferred stock has an annual dividend rate of 7 percent, the equivalent rate before taxes would be 7 X = 10.6 percent. 

Two methods are commonly used for determining the cost of owned capital. In the first method, the capital is charged at a low interest rate on the assumption that it could be used to pay off funded debts or invest in risk-free loans. The second method requires interest to be paid on the owned capital at a rate equal to the present return on all the company s capital. 

Interest is charged on the total capital investment at a set interest rate. Rates equivalent to those charged for bank loans or bonds are usually employed. Under these conditions, the total profit represents the increase over the return that would be obtained if the company could invest the same amount of money in an outside loan at the given interest rate. 

An original loan of 2000 was made at 6 percent simple interest per year for 4 years. At the end of this time, no interest had been paid and the loan was extended for 6 more years at a new, effective, compound-interest rate of 8 percent per year. What is the total amount owed at the end of the 10 years if no intermediate payments are made ... 

The total investment required for a new chemical plant is estimated at 2 million. Fifty percent of the investment will be supplied from the company s own capital. Of the remaining investment, half will come from a loan at an effective interest rate of 8 percent and the other half will come from an issue of preferred stock paying dividends at a stated effective rate of 8 percent. The income-tax rate for the company is 30 percent of pre-tax earnings. Under these conditions, how many dollars per year does the company actually lose (i.e., after taxes) by issuing preferred stock at 8 percent dividends instead of bonds at an effective interest rate of 6 percent ... 

It has been proposed that a company invest 1 million in a venture which will yield a gross income of 1 million per year. The total annual costs will be 800,000 per year including interest on the total investment at an annual rate of 8 percent. In an alternate proposal, the company can invest a total of 600,000 and receive annual net earnings (before income taxes) of 220,000 from the venture. In this case, the net earnings were determined on the basis of no interest costs. The company has 1 million of its own which it wishes to invest, and it can always obtain an effective 6 percent annual interest rate by loaning out the money. What would be the most profitable way for the company to invest its 1 million ... 

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