Facilitation session 2: Loan Amortisation……continuation of

Time value of money!

 Determination of equal periodic loan payments, necessary to provide
specified interest and repay loan principal.
 Example of annuity
 The word amortize comes from the Latin word admoritz which means
“bring to death”.
 To bring the debt to death! - retiring the debt.
 The important factors related to an amortized loan are the principal,
annual interest rate, the length of the loan and the monthly payment.
 If we know any 3 of the above factors, the fourth can be found.
 Usually the length of a loan, the annual interest rate and the amount of the loan are
known.
 But the key question is can you afford to make the monthly payment?

 The monthly payment formula is derived from the equation of future value of
annuity = future value of loan amount.
 Where P is present value/ full amount of loan
 r is the annual interest rate
 t is the length of the loan
 PMT is the monthly payment.

P   1   r r 12t
PMT  12 12
[(1  12 )  1]
r 12t
 What is the monthly payment for a loan of K29,000 for 5 years at an
annual interest rate of 5%.
29000  .05
 1   .05 (12)( 5 )
PMT  12 12
[(1   1]
.05 (12)( 5 )
12 )

 The monthly payment is K547.27

 following this schedule, you would make 60 payments of K547.27 ,
 Total interest paid to the lender is K32836.20 - K29000 = K3836.20
 Aim - divide each payment (of annuity) interest and principal
 Amortization schedule – table, containing the following
Payments, interest paid, principal paid and outstanding
principal columns
Example: Assuming Peter takes out a loan amounting K5,000 at
12% interest per year, to be repaid annually for 5 years

Amortization schedule:
Duration Payment Interest Principal Outstanding
Repaid Principal
0 5000.00
1 1387.05 600.00 787.05 4212.95
2 1387.05 505.55 881.50 3331.45
3 1387.05 399.77 987.28 2344.17
4 1387.05 281.30 1105.75 1238.42
5 1387.05 148.61 1238.44 0
 Duration Payment Interest Principal Outstanding
Repaid Principal
i = 12 %
0 5000.00
1 13875.05 600.00 787.05 4212.95
2 13875.05 505.55 881.50 3331.45
3 13875.05 399.77 987.28 2344.17
4 13875.05 281.30 1105.75 1238.42
5 13875.05 148.61 1238.44 0

I. Take the “Outstanding Principal” of the previous row, multiply it by

interest ratei, and enter the result in “Interest” column
II. “Payment” – “Interest” = “Principal Repaid”
III. “Outstanding Principal” of previous row - “Principal Repaid” =
“Outstanding Principal”
IV. Continue until the outstanding principal is 0
 Create an amortization schedule for a loan of 10,000 at 32%, to be repaid in 5
annual instalments?

 How about using using monthly payments, to be repaid in 2 years.

 How much will be the total interest paid in both cases?

Reading

Chapter 3
Pike, R. and Neale, B. (2009) Corporate Finance and Investment:
Decisions and Strategies. (FT Prentice Hall).