Question 1: CIBC Bank Amount $2,000,000 X 0.90 = $1,800,000 ✓ Solved

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The question 1 CIBC Bank Amount $2000,000 x 0.90 = 1800,000

Joanna is a civil servant who recently got a job promotion and decided to purchase a car through the bank valued at $2 million. She currently earns a monthly salary of $250,000 and wants to keep her monthly payment at below 25% of her salary due to budgetary constraints. She made inquiries with two banks who gave her the following information over the phone. CIBC offered her 90% financing with three years to repay at 8% compounded monthly. Scotiabank offered 100% financing based on her civil service membership with three years to repay at 12% compounded monthly. Payments would become due at the end of each month. Joana sought your assistance as a Finance student to help her understand the terms of the offer so that she can make her decision. Prepare the amortization schedules for both loans. Which company would be best for Joanna to accept the loan from based on her constraints and why? Three months into the loan Joanna accepted a line of credit (like a credit card) with a $650,000 limit from her bank. There is no interest payment if the line of credit is not used. However, the bank charges 30% interest compounded monthly on any outstanding balance. The impact of covid-19 caused Joanna to lose her income temporarily for two months. She was unable to make her monthly payments. Joanna decided to borrow from her line of credit so that she does not default on her loan. A month later she is back at work and is hoping to settle the outstanding sum. Advise her what would be the Effective Rate of Interest (EAR) on the credit line? Recommend to Joanna the amount outstanding for the two months, including the interest for the credit line if she had gotten the loan from CIBC.

Paper For Above Instructions

In order to assist Joanna in determining the best loan option between CIBC and Scotiabank for her car purchase, an analysis of the financing options provided by both banks is warranted. Joanna is considering a loan of $2 million to purchase a vehicle, and both banks have provided distinct terms that need to be evaluated based on her financial goals and capabilities. Therefore, this analysis will cover the calculations of loan payments, the total cost of borrowing from each bank, and an evaluation of the amortization schedules for both loans.

The first offer from CIBC entails financing 90% of the vehicle's price, thus the principal amount financed is:

  • Loan Amount = $2,000,000 x 0.90 = $1,800,000

Given an interest rate of 8% compounded monthly for 36 months, the monthly interest rate (i) can be calculated as follows:

  • i = 0.08 / 12 = 0.00666667

Using the Present Value of Annuity (PVA) formula to find the monthly payment (PMT) for CIBC's loan:

 

PVA = PMT × (1 - (1 + i)^-n) / i 


1,800,000 = PMT × (1 - (1 + 0.00666667)^-36) / 0.00666667

Calculating the PMT leads to:

 

PMT = 1,800,000 × 0.00666667 / (1 - (1 + 0.00666667)^-36) 


≈ 56405.46

Thus, Joanna's monthly payment to CIBC will be approximately $56,405.46.

Now, moving on to the offer from Scotiabank, she is presented with 100% financing at a 12% interest rate compounded monthly for the same three-year term:

  • Loan Amount = $2,000,000
  • Monthly interest rate (i) = 0.12 / 12 = 0.01

Using the same PVA formula:

 

PVA = PMT × (1 - (1 + i)^-n) / i 


2,000,000 = PMT × (1 - (1 + 0.01)^-36) / 0.01

Calculating the PMT leads to:

 

PMT = 2,000,000 × 0.01 / (1 - (1 + 0.01)^-36) 


≈ 66428.62

The monthly payment to Scotiabank will be approximately $66,428.62.

Comparing both banks, CIBC's monthly payments are lower than those of Scotiabank, which aligns more closely with Joanna's budget that restricts her payment to 25% of her monthly salary ($62,500). Since CIBC's payments of approximately $56,405.46 fall within her budget, it is advisable for Joanna to choose the CIBC loan. However, she must also consider the total cost of the loan, which over three years will amount to:

  • Total Payment to CIBC = $56,405.46 × 36 = $2,028,197.56
  • Total Payment to Scotiabank = $66,428.62 × 36 = $2,392,001.32

This analysis indicates that CIBC is the superior financial option exceeding savings in total payments.

Next, related to Joanna's line of credit, she will face a monthly interest charge of 30%. To calculate the Effective Rate of Interest (EAR) of her credit line when outstanding for two months, we can use the following formula:

EAR = (1 + i)^m - 1

Where i is the monthly interest rate, and m is the number of periods:

EAR = (1 + 0.30)^2 - 1 = 0.69 or 69%

This high rate indicates the cost associated with using the line of credit from her bank.

Calculating the outstanding amount due including interest from the line of credit after two months, we first calculate the outstanding principal after those months:

Outstanding Amount = $56,405.46 (monthly payment) × 2 = $112,810.92 


Interest for the two months = 0.69 / 12 = 0.0575 


Total interest due = 0.0575 × 112,810.92 = $6,505.16 


Total Amount Due = 112,810.92 + 6,505.16 = $119,316.08

Ultimately, Joanna should be advised to consider CIBC for the vehicle loan as it shows favorable terms compared to the Scotiabank loan while also being manageable within her budget constraints.

References

  • Brigham, E. F., & Ehrhardt, M. C. (2013). Financial Management: Theory & Practice. Cengage Learning.
  • Ross, S. A., Westerfield, R. W., & Jaffe, J. (2016). Corporate Finance. McGraw-Hill Education.
  • Investopedia. (2023). Present Value of Annuity Formula. Retrieved from https://www.investopedia.com/terms/p/present-value-annuity.asp
  • Financial Industry Regulatory Authority. (2023). Understanding Interest Rates. Retrieved from https://www.finra.org/investors/insights/understanding-interest-rates
  • Pinto, J. E., Henry, E., & Robinson, J. (2015). Financial Modeling in Excel for Dummies. Wiley.
  • Graham, B., & Dodd, D. L. (2008). Security Analysis. McGraw-Hill Education.
  • Damodaran, A. (2010). Applied Corporate Finance. Wiley.
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  • Khan, M. Y., & Jain, P. K. (2011). Financial Management. Tata McGraw-Hill Education.
  • Morley, A. (2020). The Ultimate Guide to Credit Cards. MoneySavingExpert.com.

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