Accounting & Financial Management

Questions: 1.What is the monthly payment? 2.How much of the first payment is interest? 3.How much of the first payment is principal? 4. How much will Casino.com Corporation owe on this loan after making monthly payments for three years (the amount owed immediately after the thirty-sixth payment)? 5.Should this loan be refinanced after three years with a new seven-year 7 per cent loan, if the cost to refinance is $250,000? To make this decision, calculate the new loan payments and then the present value of the difference in the loan payments? 6.Demonstrated knowledge of the nature of a bank, financial risks and asymmetric information? Answers: 1. The monthly payment for the present loan will be as follows: Calculation of Monthly Payments:- Particulars Amount Loan Amount $20,000,000 Period (in years) 10 Interest Rate p.a. 8% Nos. of Payments p.a. 12 No. of total Monthly Payments 120 Effective Interest Rate 0.67% Amount of Monthly Payments $242,655.19 2. The interest of the first payment is computed below: Calculation of Interest Amount on First Payment:- Particulars Amount Loan Amount $20,000,000 Interest Rate p.a. 8% Nos. of Payments p.a. 12 Effective Interest Rate 0.67% Interest on First Payment $133,333 3. The principal of the first payment will be as per the following table: Calculation of Principal Amount on First Payment:- Particulars Amount Amount of Monthly Payments $242,655 Interest on First Payment $133,333 Principal on First Payment $109,322 4. The balance loan amount after paying the monthly installments for first 3 years will be $15,568,578, as per the following table: Period Opening Balance Interest Rate Interest Amount Monthly Payment Principal Amount Due Balance 1 $20,000,000 0.67% $133,333 $242,655 $109,322 $19,890,678 2 $19,890,678 0.67% $132,605 $242,655 $110,051 $19,780,627 3 $19,780,627 0.67% $131,871 $242,655 $110,784 $19,669,843 4 $19,669,843 0.67% $131,132 $242,655 $111,523 $19,558,320 5 $19,558,320 0.67% $130,389 $242,655 $112,266 $19,446,054 6 $19,446,054 0.67% $129,640 $242,655 $113,015 $19,333,039 7 $19,333,039 0.67% $128,887 $242,655 $113,768 $19,219,271 8 $19,219,271 0.67% $128,128 $242,655 $114,527 $19,104,744 9 $19,104,744 0.67% $127,365 $242,655 $115,290 $18,989,454 10 $18,989,454 0.67% $126,596 $242,655 $116,059 $18,873,395 11 $18,873,395 0.67% $125,823 $242,655 $116,833 $18,756,562 12 $18,756,562 0.67% $125,044 $242,655 $117,611 $18,638,951 13 $18,638,951 0.67% $124,260 $242,655 $118,396 $18,520,555 14 $18,520,555 0.67% $123,470 $242,655 $119,185 $18,401,371 15 $18,401,371 0.67% $122,676 $242,655 $119,979 $18,281,391 16 $18,281,391 0.67% $121,876 $242,655 $120,779 $18,160,612 17 $18,160,612 0.67% $121,071 $242,655 $121,584 $18,039,028 18 $18,039,028 0.67% $120,260 $242,655 $122,395 $17,916,633 19 $17,916,633 0.67% $119,444 $242,655 $123,211 $17,793,422 20 $17,793,422 0.67% $118,623 $242,655 $124,032 $17,669,389 21 $17,669,389 0.67% $117,796 $242,655 $124,859 $17,544,530 22 $17,544,530 0.67% $116,964 $242,655 $125,692 $17,418,838 23 $17,418,838 0.67% $116,126 $242,655 $126,530 $17,292,309 24 $17,292,309 0.67% $115,282 $242,655 $127,373 $17,164,936 25 $17,164,936 0.67% $114,433 $242,655 $128,222 $17,036,713 26 $17,036,713 0.67% $113,578 $242,655 $129,077 $16,907,636 27 $16,907,636 0.67% $112,718 $242,655 $129,938 $16,777,699 28 $16,777,699 0.67% $111,851 $242,655 $130,804 $16,646,895 29 $16,646,895 0.67% $110,979 $242,655 $131,676 $16,515,219 30 $16,515,219 0.67% $110,101 $242,655 $132,554 $16,382,665 31 $16,382,665 0.67% $109,218 $242,655 $133,437 $16,249,228 32 $16,249,228 0.67% $108,328 $242,655 $134,327 $16,114,901 33 $16,114,901 0.67% $107,433 $242,655 $135,223 $15,979,678 34 $15,979,678 0.67% $106,531 $242,655 $136,124 $15,843,554 35 $15,843,554 0.67% $105,624 $242,655 $137,031 $15,706,523 36 $15,706,523 0.67% $104,710 $242,655 $137,945 $15,568,578 5. If the company would refinance the loan with a new loan for seven years with 7% interest along with $250,000, as cost of finance, then the amount of new loan payments will be as follows: Calculation for Payment for New Loan:- Particulars Amount Amount of New Loan $15,568,578 Period (in years) 7 Interest Rate p.a. 7% Nos. of Payments p.a. 12 No. of total Monthly Payments 84 Effective Interest Rate 0.58% Payment for New Loan $25,376,689 The difference between the present values of two loan amounts is calculated below: Difference between two loan amounts:- Particulars Amount Amount of New Loan Payment $25,376,689 Interest Rate 7% Period (in years) 10 Present Value of New Loan Payment $12,900,222 Cost of Finance $250,000 Interest Rate 7% Period (in years) 3 Present Value of Refinancing Cost $204,074 Present Value of Total New Loan $13,104,296 Balance of the Old Loan $15,568,578 Interest Rate 8% Period (in years) 7 Future Value of Balance Loan after Ten Years $26,681,806 Total Period (in years) 10 Present Value of the Balance Loan $12,358,839 Difference between Old and New Loan $745,457 As per the above, the present value of new loan would be higher than the present value of old loan. It indicates that the company has to spent higher interest for the old loan in comparison to the new loan, though the new loan would cause to additional cost of finance. Therefore, it can be stated that the company should refinance the loan after three years to reduce the interest expenses. 6. Banks are regarded as the unique financial institutions due to the particular mix of features. This makes them vulnerable to run with negative externalities for the economy and has potentially systematic consequences. Financial regulations coms at the cost of regulatory failure. Large banks diversify by shifting form the traditional deposit taking and lending it to the market based activities and wholesale funding that is more cost effective (Beatty and Liao 2014). Banks operate in the condition of fractional liquidity reserve and the majority of the assets are more illiquid loans. Banks would face serious problems if all the depositors demanded their money at the same time. Banks have added a wide range of market based operations and large banks are engaged in the market-based activities. Capital held by large banks is less as compared to small banks as they have less stability funding than the small banks (Imf.org 2017). They are more organizationally complex as they have number of subsidiaries. The systematic risk of the large banks refers to the externalities of the banking distress onto the real economy or the financial system. Since they are more engaged in the market based activities as measured by the share of the loan in the total assets or the share of non-interest income in the total income. Large banks operates in such way because of the economies of the scale is benign. Size of banks is regarded as economically beneficial and the size of banks may be large as compared to what is regarded as socially optimal. Bank size is related with the private interest of the shareholders and the managers (Internationalcompetitionnetwork.org 2017).The tradeoff between the bank size and the economies of scale concerning negative externalities would contribute to the systematic risk of the banks. The regulations of banking emerge from the microeconomic concern of the bank over the ability of the creditors of the bank to monitor the risks originating from the lending side over the stability of the banking system. The banking regulation theory has undergone significant changes due to the compounding effects occurring in the financial sector. Regulations has also been evolving due to the ongoing banking crisis. Asymmetric information theory has profound effect on regulation view (Lse.ac.uk 2017). It has been argued by the majority of authors that there is an important asymmetry between the information available to the outside investors, depositors and banks. In extreme case of the information asymmetry, it is not possible for the depositor to distinguish between the insolvent and solvent banks. It might be possible that the banks operates at the size that is quite large from a perspective of social welfare. The optimal size of banks is uncertain due to the potential for economies of scale in large banks. Larger banks creates risk that is more systematic and are more risky than small banks. The individual bank risk is not influenced by the involvement of large banks in market-based activities. However, this give rise to the systematic risk. Regulation deals with the organizational complexity of the banks, which facilities the orderly resolution of the complex banks and reducing the complexity with the help of ex ante incentives. Taxing on the size of the large banks would seek to correct the large negative externality of the banks as the systematic risk for the large banks are too big. Some significant social costs are generated by the size of the banks and the negative externality forces the organization to take up such risks. Banks will be able to internalize the social costs with the help of tax imposed on the size of the banks. Larger the size of the banks, it is less likely for the government to allow it to fail and it is shielded from the potential loss. The size of the banking industry is not regarded as the biggest issue. It is viewed in light of the investment by the investor in the large banks. Since the government effectively guarantees the debts too big to fail and amount of deposits, the investment with large banks as the safer investment than made with the small banks. If the externalities are created by size and such externality can be limited by imposing tax. It can be done through the capital requirements that are considered progressive in relation to the size of the business. As long as the banks are allowed to remain big by the regulators, the political leverage of the banks will also continue to be big. The economic tab and the taxpayer created by them will also be regarded as big (Kaplan and Atkinson 2015). If the regulators break up the large banks, then this will put the financial institutions at the competitive disadvantage position. Safety of the global financial sector will not be improved with this strategy. The managers can boost the size of the banks by increasing the leverage of the banks and attracting the additional funding. The study conducted details the scope and optimal size of the large banks. It has been observed that large banks create more systematic risk on average than smaller banks. Risks of such banks are high when they have unstable funding; insufficient capital and they are organizationally complex and engage in more market-based activities (Saunders and Cornett 2014). It is suggested by the literature that the size of banks are driven by the empire building incentives and too big to fail subsidies. In addition to this, the size of the banks are large from the perspective of the social welfare. However, the optimal size of banks are highly uncertain and the regulations restricting the size of the banks may be imprecise and difficult to implement. The regulations of large banks should be optimal and it should combine the macro and micro prudential perspectives. This may involve the measures to reduce the involvement of the large banks in the organizational complexity and market base activities (Petty et al. 2015). Moreover, capital surcharges on large banks are also included. Reference: Beatty, A. and Liao, S., 2014. Financial accounting in the banking industry: A review of the empirical literature.Journal of Accounting and Economics,58(2), pp.339-383. Imf.org. (2017). 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