Ch 6 Cyberproblem Assinment
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The data you will need for the prepayment scenario include the following.
Loan Balance: $135000
Current Payment: $990.62
Additional Payment: $50.00
Loan Interest Rate: 8.0%
Loan Interest Deductibility: YES
Investment Rate Return: 6.00%*
Tax Bracket: 30.00%
Investment Type: After-Tax
*The Investment rate return is your opportunity cost estimate. It is the annual rate you think you can earn on the $50 extra principal payment if you did not make extra principal payments on your mortgage but instead, invested it.
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A. After 12 months of making extra payments, what will be the loan balance?
It is the loan balance – current payment Ð- additional payment x .06% x 12 months
The loan balance is $133,249.29
B. After 12 months of making the regular payment and investing the $50, what will be the loan balance?
It is the loan balance Ð- current payment x .06% x 12 months
The loan balance is $133,871.79
C. Under the regular payment and investing option, excluding the tax due on the interest earned, what is the investment balance after 12 months?
Current payment+0.06% x 0.08%
The investment balance is $623.64
D. Compare the scenarios of investment versus prepayment by examining the 60th payment, which occurs at the end of the fifth year. What is the difference between the (a) interest portion of that payment, (b) tax deduction for interest, and (c) principal balance? Finally, how much is in the investment account?
I did this with calculator after knowing the balance.
The investment balance is $623.64
Interest payment under prepayment is 832.51 while under investment is 856.50
Tax deduction for Interest payment under prepayment is 249.75 while under investment is 256.95
Principle balance under prepayment is 1242,667.68 while under investment is 128,341.53
Investment account is 3,602.75 and tax due on investment account is 57.61
E.(a) How long does it take to repay the entire loan under the prepayment option? (b) What is the total interest paid over the life of the loan?
Loan payback period under prepay is 25.083 years or 301 months.
Total interest paid = 178,461.11
F. Compare the total interest paid under each scenario? How much less in interest do you pay under the prepayment option?
Total interest paid under investment plan is 221,560.64. So under investment plan the excess interest paid is 221,560.64-178,461.11=43,099.53
G.If you make an extra $50.00 principal payment per month, what are the opportunity cost considerations?
Opportunity cost is the return which can be earned on the investments.
H. What are the relevant cash flows to consider in this decision? For example, do you consider the tax implications and if so, then how?
The relevant cash flows are given below. The sign of the cash flow is indicated in brackets.
Repayment of extra principle = Negative
Interest savings on mortgage due to additional principle repayment = Positive
Reduction in tax benefits on interest paid on mortgage = Negative
Opportunity cost (return lost on investment) = Negative
Tax payments on income earned from investments under investment option = Positive
OUTPUT
Loan Balance
135,000.00
Current Payment
990.62
Additional Payment
50.00
Loan Interest Rate
8.00 %
Loan Interest Deductibilty
Yes
Investment Return Rate
6.00 %
Tax Bracket
30.00 %
Investment Type
After-Tax
Summary
Prepay
Invest
Total Interest (25.083 yrs)
178,461.11
221,560.64
Loan Payback Time (Years)
25.083
29.917
Investment – Loan Balance : $ -7,917.89
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