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Hello sir pls help me answer this, ive found the effective rate as 12.68% but i just dont understand how to go about this ques:
Another supplier who Jeeps co now
waits 90 days to pay, has been threatning legal action over the $300000 currently owed. Jeeps co feels that some sort of
compromise might be neededJeeps co cost of capital is 12% per annum
Assume that there are 30 days in a month and that purchases accrue evenly over the yearQuestion D
To avoid a court action, jeeps co is thinking of offering to repay the creditor it owes $300,000 in installments as follows (all figures in $000)
now- 75
1 month- 45
2 months- 45
3 months- 45
4 months- 45
5 months- 45How much will jeeps co save, in present value terms, if the creditors accepts the instalment offer instead of jeeps having to pay in full immediately (to the nearest $00)?
This is a very strange question (because it involves monthly discounting) and I cannot see it being asked in the real exam.
However to get the PV of the repayments you need to multiply 45 by the annuity factor for 5 periods at the monthly interest rate (using the formula provided to calculated the annuity factor) and add the 75 payable immediately.
The monthly interest rate is (12th root of 1.12) – 1.
I am surprised that the Kaplan Kit does not show the answer and the workings for it. 🙂
Sir I apologize for not being able to understand the logic/ formula behind the monthly interest rate, It’d help immensely if you could explain that?
And why can’t we just divide effective interest rate of 12.68% by 12 months?
Had the interest rate been 1% per month, then the effective annual rate would indeed be
(1.01^12) – 1 = 0.1268 or 12.68%.However the interest rate is not 1% per month but is 12% per year.
We need the monthly rate and so we have to work backwards and use the same logic as you were using in arriving at 12.68%, but if the monthly rate is r, then ((1+r)^12 – 1) = 0.12
Thank you I understand the monthly rate calculation….
but Sir why are we calculating monthly rate like that? I mean why can’t we use 12%/12 months… Can you clarify that in terms of compounding..
As in we borrow 45 for 5 months so each time we calculate interest on 45 alone?
If the interest rate is ‘r’ per month, then the principal is multiplied by 1+r each months and so after 12 months it grows by (1+r)^12.
If you are still unclear then do look at the Paper MA lectures on interest, where this is all explained.Given that it is an equal amount of 45 for each of five months, we discount it by multiplying 45 by the annuity factor for 5 periods at the monthly interest rate. Obviously it is not possible to use the tables because the monthly interest rate is not given in the tables. So it means calculating the annuity factor using the formula provided. Again, this is really Paper MA and the MA lectures on discounting show how to do this.
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