Week 16_LanreGiwa_Plans for Repayment of Loan

Problem Recognition / Identification

Due to the global economic melt down affecting my country and particularly my business, I had to take a loan to sustain my business. The total amount I collected from a friend is NGN 200,000 and I have assured my friend that I will pay back with interest over a period of 4 years. Being a friend, he said I should think of a plan for the replacement of the loan taken over the period agreed. We both checked the country’s inflation index and pegged the interest rate 5 % per annum on the principal sum loaned. The interest rate is very conservative because my friend gave me some concessions.

Development of Feasible Alternatives/Solutions

For this task, I have thought of three alternatives or plans on the load repayment and would then consider which will be best for me since my friend gave me the option to use the plan that will be very convenient for me.

Plan 1 – I will pay the principal sum at the end of the 4^th year while I pay the interest due at the end of each year

Plan 2 – I will pay in instalments by paying the calculated amount (principal and interest) annually

Alternative 3 – I will wait till end of the fourth year and pay everything together .i.e Principal and accrued interest.

Possible Outcomes and Cash Flow of Alternatives / Solutions

Plan 1: In plan 1, none of the principal sum will be paid till the fourth year while the interest will be paid at the end of each year. With this plan, the cash outflow will be minimal for me in the 1^st 3 years while I will take advantage of the time value of money to make more money and repay all by the end of the 4^th year. Plan 1 will not make the interest rate gather up, hence, the interest rate will not be compounded and this makes economic sense.

Plan 2: The second plan is to calculate the principal sum with the applicable compound interest over the four year period and divide it into 4 equal parts for payments. The cash flow effect is that a quarter of the total sum will be paid and will require that a considerable cash outflow will happen at end of each year. The good part of this option is that the total amount of interest to be paid will be less

Alternative 3: With plan 3, no interest and no principal will be paid in the first 3 years until the end of the 4^th year when everything will be paid. The cost of funds as regards the compound interest will be very high compared to the other two options. The advantage is that once can take the advantage of the long time to repay to quickly turn over the funds for more money.

Selection Criteria / Attributes of best solution

• Convenience of payment
• The cheapest option in terms of final amount payable.
• Time value of Money

Analysis and comparison of the Alternatives/Solutions

The analysis was carried out by quantitative analysis using excel spreadsheet and the values are shown below:

Duration ( Year)	Amount owed at beginning of Year	Interest accrued for the Year	Total Money owed at end of the Year	Principal Payment	Total End of the Year payment ( Cash Flow)
PLAN 1	Pay interest due at the end of each year and principal at the end of the 4th year
1	200,000.00	10,000.00	210,000.00	0	10,000.00
2	200,000.00	10,000.00	210,000.00	0	10,000.00
3	200,000.00	10,000.00	210,000.00	0	10,000.00
4	200,000.00	10,000.00	210,000.00	200000	210,000.00
		40,000.00
TOTAL AMOUNT PAYABLE FOR PLAN 1			240,000.00
PLAN 2	Pay the interest and principal sum in four equal installments at the end of each year
1	200,000.00	10,000.00	210,000.00	0	56402.37
2	153,597.63	7,679.88	161,277.52	0	56402.37
3	104,875.15	5,243.76	110,118.91	0	56402.37
4	53,716.54	2,685.83	56,402.37	200000	56402.37
		25,609.47
TOTAL AMOUNT PAYABLE FOR PLAN 2			225,609.47
PLAN 3	Pay principal sum and interest at once at the end of the 4th year
1	200,000.00	10,000.00	210,000.00	0	-
2	210,000.00	10,500.00	220,500.00	0	-
3	220,500.00	11,025.00	231,525.00	0	-
4	231,525.00	11,576.25	243,101.25	200000	243,101.25
		43,101.25
TOTAL AMOUNT PAYABLE FOR PLAN 3			243,101.25

Best Alternative to be Selected

Amongst all the options analyzed, Plan 2 is the cheapest option that is available to me in terms of the total amount that i will pay my friend back. Though I may need to work hard to get the funds available at the end of each year, I still prefer that option compared to the remaining two options available to me.

Performance Monitoring / Post evaluation

For performance monitoring and post evaluation, I will consider how comfortable it will be for me to pay the money at the end of each year and if its worth taking this option. In the future, I will experiment taking a loan and paying back on the other plans to evaluate effectively the best plan of the three.

References:

1. AACE International. Skills & Knowledge of Cost Engineering, 5^th Edition Revised.Chapter-13, pp.13.1-13.7 Edited by Dr. Scott J. Amos, PE. 2010. AACE International. Morgantown, WV, USA.

2. Sulliven, W. G., Wicks, E.M., Koelling, C. P., et al. (2009). Engineering Economy (14^th ed.), Chp 4 pp104 -135. New Jersey: Pearson Education.
3. Brassard M, Ritter D. The memory Jogger 2. Tools for Continuous Improvement and Effective Planning.2010.