A shipping company has just taken delivery of an £8 million cargo vessel. The payment terms imposed by the shipyard are that 25% of the amount due must be paid immediately, but that the outstanding balance can be repaid in five equal annual instalments. The shipyard will, however, charge an annual flat rate interest charge of 10% of the incurred debt for each year that there is any debt outstanding.
(a) If the first instalment is to be made one year from now, calculate the size of the five equal payments that will have to be made by the shipping company and the APR on this loan arrangement.
(b) Funds are also available from the shipping company's bankers at a rate of 10.5% per annum compounded annually. This would mean that the outstanding debt to the builders could be borrowed from the bank and cleared off immediately.
Which of the two loan arrangements should the shipping company use in terms of offering the lowest APR?
(c) In addition, however, suppose that the shipyard offered the shipping company a deal whereby (after the initial 25% payment) no interest was charged and no further payments were due until 2 years after the ship was delivered, would this make any difference to the decision reached in part (ii) above?