Reference no: EM133326449
Case: You have decided to purchase an industrial warehouse. The purchase price is $1 million. You have narrowed your choice of debt financing packages to the following two alternatives:
a. $700,000 loan, 6 percent interest rate, 30-year term, annual, interest-only payments (the annual payment will not include any amortization of principal), and $50,000 in up-front financing costs.
b. $750,000 loan, 6 percent interest rate, 30-year term, annual, interest-only payments. No up-front financing costs.
What is the difference in the present value of these two investment alternatives? Assume the appropriate discount rate is 6 percent.
Solution: Please explain how the numbers in brackets were solved with a financial calculator:
The difference in NPVs is $50,000: Option "A" is more expensive.
Present value of Option A is $1,050,000: initial equity ($300,000) + upfront financing fees ($50,000) + present value of interest payments ($578,123) + present value of loan principal upon repayment ($121,877).
Present value of Option B is $1,000,000: initial equity ($250,000) + present value of interest payments ($619,417) + present value of loan principal upon repayment ($130,583).
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