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(^366) Financial Management
residual itemñthe difference between the annual payment and the tenth-year beginning
balance.
Balloon Payment Amortisation. On occasion firms prefer to amortise less than the
full amount of the loan. Amortising only a portion of the term loan results in the firmís
making a relatively large or ìballoonî payment when the loan matures. One reason for
doing this may be that the unamortised portion of the loan on maturity may equal the
anticipated salvage value of the equipment to be purchased with the term loan. Another
reason is that with a balloon payment the firmís annual payments are smaller, except of
course for the last payment, which includes the unamortised loan. A firm may choose
a balloon payment with the idea of refinancing the unamortised loan at maturity.
Assume that Central Manufacturing and the lending bank agree to amortise Rs 600,000
of the Rs 800,000, with the unamortised portion or Rs 200,000 due at the end of the
tenth year. One way to evaluate this term loan is to view it as two separate loans-one
for Rs 600,000 and one for Rs 200,000. The annual payment for Rs 600,000 portion is
determined by using Equation 2;
P = Rs 600,000 / 6.4177 = Rs 93,491.44
The Rs 200,000 portion is not repaid until the last year. Interest due every year for 10
years on this amount is Rs 200,000 ◊ 0.09% = 18,000. Total annual payment for the first
9 years on this loan is Rs 93,491.44 + Rs 18,000 = Rs 111,491.44. The tenth and final
payment would include the unamortised portion of the loan also and would equal Rs
111,491.44 + Rs 200,000 = Rs 311,491.44.
In this section we have considered two alternative, term loan repayment procedures.
Variations would include situations in which the applicable interest rate is not fixed or
the annual payment amount is not fixed. The technique for amortising term loans of
these types is similar to the procedure outlined in Table 4.
Advantages and Disadvantages of Term Loans
As with any financing procedure, term loans are not without their advantages and
disadvantages.
Advantages. The relationship between borrower and lender is one-to-one, and it is
easy for them to negotiate loans terms that meet the special need of the borrower.
Repayment schedules, annual payments, and maturity date can be negotiated to meet
the borrowerís needs. The borrower also finds it easy to negotiate with one lender and
does not have to go through a Securities and Exchange Commission registration as is
the case with typical bond financing. The lending institution also may not seek certain
financial information that the firm may be hesitant to divulge. Term loans can be arranged