On January 1, 2021, Red, Inc. borrowed cash by issuing a $500,000, 5-year note that specified 6% interest to be paid on December 31 of each year and the $500,000 to be paid at maturity. If the note had instead been an installment note to be paid in four equal payments at the end of each year beginning December 31, 2021, which of the following would be true?

The annual cash payment would have been less.

The first year's interest expense would have been higher.

The second year's interest expense would have been less.

The effective interest rate would have been higher.

Question

07-02-2020
Business

contestada

On January 1, 2021, Red, Inc. borrowed cash by issuing a $500,000, 5-year note that specified 6% interest to be paid on December 31 of each year and the $500,000 to be paid at maturity. If the note had instead been an installment note to be paid in four equal payments at the end of each year beginning December 31, 2021, which of the following would be true?

The annual cash payment would have been less.

The first year's interest expense would have been higher.

The second year's interest expense would have been less.

The effective interest rate would have been higher.

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andromache andromache · Answer 1 · 2020-02-10T08:01:27+01:00

Answer:

The second year's interest expense would have been less.

Explanation:

Given that

Interest rate = 6%

Borrowing cash for 5 year note = $500,000

So, the interest expense

= Borrowing cash for 5-year note × Interest rate

= $500,000 × 6%

= $30,000

Now for an installment note, we have to consider both interest and the principal payment

So, the first option is false, as the annual cash payment is more instead of loss

The second option is also false as it the first year interest payment would remain the same instead of being higher

The third option is correct as the principal amount plus the interest expense would get reduced by their actual amount because of the first payment with regard to principal and interest

And, the fourth option is wrong as the effective interest rate would be less instead of being higher

bratislava bratislava · Answer 2 · 2021-12-08T11:17:41+01:00

January 1, 2021, red inc borrowed cash by issuing a $500,000 note that had an interest of 6% to be paid on December 31. There would be a payment of $500,000 each year as maturity.

As Interest rate = 6% Borrowing cash for 5 year note = $500,000.

Hence interest expense equals to cash for 5-year note × Interest rate = $500,000 × 6% = $30,000

As for the installment notes, we consider both interest and principal payment. Thus the second year's interests expense would be less.

Hence the option C is correct.

Learn more about the Red, Inc. borrowed cash by issuing.

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