Question

Assume that as a local government financial analyst you are asked to project the feasibility of a loan to a proposed public service venture for its start-up funding. The venture’s principals estimate that, at the end of 5 years, they will be able to pay back up to $800,000 from revenues accruing to the venture’s activities. Assuming that your organization’s current “average cost of capital” is 4.8% (the “discount rate”). Assuming monthly compounding, what is the maximum amount your government can commit to the venture for its start-up?

Step 1

Please recall the formula for compounding.

If P is the principal, R is the interest rate, N is the period and A is the compounded amount then the equation connecting all these variables is as shown on the whiteboard.

Step 2

Let's now look at the question. The maximum amount that borrower can pay at the end of 5 year is $ 800,000. Cost of capital is 4.8%. Thecost of capital is compounded monthly.

Step 3

So we now have the inputs for out model ready,

A = 800,000;

Cost of capital is 4.8% per annum. Since compounding takes place every month we will have top figure out cost o...

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