United Arab Emirates Small Business Loan (A) Mohammad tried one last time to explain the loan structure offered by the company’s UAE bank. His boss just stared at him. Mo explained the detailed calculation of annual interest and principal payments, step-by-step, as detailed by the bank.
The loan was for USD5 million, for five years, with an 8.200% interest rate.
Step 1: Calculate interest on Loan Principal for one year
Step 2: Multiply that interest by the number of years of the loan. The bank labeled this "Total Interest."
Step 3: Add the calculated Total Interest to the Loan Principal.
Step 4: Divide this calculated total by the number of years of the loan. This is the annual payment due on the loan (principal and interest).
Step 5: Using the calculated annual payment from step 4, structure the repayments to maake all interest payments (totaling to Total Interest from Step 2) up-front. Once all interest has been paid, the remaining cash flows associated with the annual payment are considered repayment of principal.
a. Following the 5 steps described, lay out the principal and interest payments on the loan agreement.
b. Calculate effective cost of funds on the loan agreement (the all-in-cost).
c. Lay out the principal and interest payments on the same loan if it was a 'normal' amortizing loan.
d. What is your assessment of the loan?
a. The loan calculations would appear as follows.
Loan 0
Loan Principal $ 5,000,000.00
Interest rate 8.2000%
Maturity (years) 5.0
a. The principal and interest payments on the loan structure described.
Payments 0 1 2 3 4 5
Funds raised
Interest payment
Principal payment
Total cash flows
b. The effective cost of funds, the all-in-cost (AIC) on the loan, is found by finding the IRR of the cash flow series.
AIC (IRR)
c. If the same loan was structured as a normal amortizing loan:
Payments 0 1 2 3 4 5
Funds raised
Interest payment
Principal payment
Total cash flows
AIC (IRR)
d. What is your assessment of the loan?