Question

A borrower has two alternatives for a loan:

Answer 1

Answer:

The second alternative is the best option for the borrower as it provides the less amount of interest expense.

Explanation:

We solve for the interest expense on each alternative and pick the lowest:

(1) common note.

$Principal \: (1+ r)^{time} = Amount$

Principal 420,000.00

time 0.25

rate 0.04000

$420000 \: (1+ 0.04)^{0.25} = Amount$

Amount 424,138.43

Interest expense:   4,138.43‬

(2) Discounted note:

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity  $420,000.00

time  0.25

rate  0.04000

$\frac{420000}{(1 + 0.04)^{0.25} } = PV$  

PV   415,901.9490

THe borrower recieve this amount and then, return 420,000

Interest over time  4,098.05099