Answer:
a. Amount of Interest year 1
Under option 1 = $12,000
Under option 2 = $12,000
b. Amount of Interest year 2
Under option 1 = $12,000
Under option 2 = $10,800
c. Which option is more advantageous to Sanders?
B. Option 2
With option 2, interest decreases as the years pass.
Explanation:
(1) to issue a note with the principal due in 10 years and with interest payable annually
Notes payable $150,000
Interest expense per year = $150,000 x 8% = $12,000
or (2) to issue a note to repay $15,000 of the principal each year along with the annual interest based on the unpaid principal balance.
Note payable $15,000 + ($150,000 x 8%) = $27,000
interest expense year 1 = $12,000
year 2:
Note payable $15,000 + ($135,000 x 8%) = $25,800
interest expense year 1 = $10,800
The amount of interest that Sanders will pay in year 1 under option 1 and under option 2 will be both be $12000.
The amount of interest that Sanders will pay in year 2 under option 1 and under option 2 will be $12000 and $10800 respectively.
Since the notes payable is $150000, the interest is calculated as:
= 8% × $150000
= $12000
For the second year, the notes payable will be calculated thus:
= 8% × $135000
= 0.08 × $135000
= $25800
Also, the interest expense is $10800.
Therefore, it can be deduced that with option 2, the interest reduces, therefore, it's more advantageous.
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