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Borrowing funds to meet customer requirements and debt

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?

Show all work and calculations to include selected formulae.

Based on your calculations what is the minimum estimate that your organization should provide on your proposal to the customer and why is this so?

Solution Preview

This project is concerned with the financial principle of future value and compounding. We are trying to determine the future value of the $20 million (for 5 years at a compounded annual interest rate of 10%). The formula for this is:

Principal (P) = 1 x 1 + interest rate (i); therefore

Year 1: $20,000,000 x 1.1 =22,000,000
Year 2: $22,000,000 x 1.1 =24,200,000
Year 3: $24,200,000 x 1.1 =26,620,000
Year 4: $26,620,000 x 1.1 =29,282,000
Year 5: $29,282,000 x 1.1 =32,210,200 (this represents the total cost of the project over the 5 year life cycle - ...

Solution Summary

How to analyze (in simple terms) the rate of return on an investment, using the principles of compounding and discounting to determine either the amount needed for investing purposes, and/or the amount required to determine an effective return rate.

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