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Hi John
this is a really simple question, but it confuses me despite many attempts.
this is from my revision kit:
a company has loan for seven years of $140 million, at 6% interest.
if the loan increases (i.e. they borrow even more money), the interest increases by 25 basis points.
if the loan decreases (they pay more of the current amount off) the interest decreases by 15 basis points.proposal one: the company loans out a further $20 million. additional interest charge is: ($960,000 + $320,000).
proposal two: sell an asset for $27 million cash and uses this to reduce the non-current liability. interest saved is ($1,296,000 + $136,000)
Here is my approach:
proposal one: 6% = 0.06, 25 basis points = 0.25% =0.0025
0.0025 * 140m = $350,000 ?
0.0625 * 20m = $1.25m ? (this is different from the answer above, so wrong)proposal two: 15 basis points = 0.15% = 0.0015. interest saved is
0.0015 * (140m -27) = 169,500 ? (again wrong)what am i doing wrong?
I have no idea where the figures from the answer in your book are coming from.
If it is in the BPP Revision Kit, then please tell me which question so that I can see the
whole question.(Your workings for the reduction of the loan are wrong because they are saving the full interest on the amount repaid, not just the 0.15%)
ah yes I see what you mean. Thanks John.
it’s from the Kaplan kit, but the question is titled “Ennea (Jun 12)”, so apparently it’s from a past paper (June 2012), so may be in the BPP kit too. (I would not like to trouble you too much John, so if it would take too much effort to look it up that is ok I will just skip that question).
(the above calculation is only a part of the question workings. the rest made sense).
I have used BPP before they are much better in terms of clearer answers. This Kaplan book often skips explanations of steps, so I would not recommend it. The only reason I chose Kaplan this time is because they divide the questions by topic area.
Kaplan have simply copied out the examiners own answer.
Your approach is fine, but you had not mentioned the fact that there is 20% tax and that therefore the extra cost to the company is after tax.
So the extra interest payable is (350,000 + 1,250,000) x 0.8 = 1,280,000, which in total is exactly the same as the total in the examiners answer.
Thanks John. My apologies to Kaplan.
I did not know to include tax at that point when I tried that question. but actually putting in the ( x .80 ) does make things much clearer.
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