Your assigned project is projected at an estimated order of magnitude to cost $20 million over the course of 5 years. Your organization intends to borrow the entire cost up front to meet customer requirements and pay the debt off over the 5-year life of the project at an interest rate of 10% compounded annually. Including the principle and interest, what is the total cost of your project at the end of the five year life cycle?
SAMPLE ANSWER
The concept of using compound interest enables one to know the exact amount of money that certain loan will amount to over a given duration. The concepts works in a unique way in that the interest earned over the first period is added to the principal when calculating the interest for the next period. The pattern continues in that manner until the end of the project term. For this assigned project, the loan is worth 20 million payable over a period of five years. The applicable interest rate over that period will be constant at 10 %. Since there is an interest payable, the net worth of the project will definitely be much higher than the initial amount of 20 million that was borrowed. Calculations to get the net worth of the project will be calculated as follows:
Year Loan at start Interest loan at End
0 20,000,000 (20,000,000*10%) = 2,000,000 $ 22,000,000
1 22,000,000 (22,000,000*10%) = 2,200,000 $24,200,000
2 24,200,000 (24200000*10%) = 2,420,000 $26,620,000
3 26,620,000 (26,620,000*10%) 2662000 $29,282,000
4 29,282,000 (29,282,000*10%) = 2,928,200 $32,210,200
5 32,210200 (32,210,200*10%) = 3,221,020 $35,431,220
Therefore, at the end of the five years repayment, the project will be worth $35, 431,220
The principal amount of $20 million will have been paid back with an interest of $15,431,220
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