Dodson Co. is planning to finance an expansion of its operations by borrowing $120,000. City Bank has agreed to loan Dodson the funds. Dodson has two repayment options: (1) to issue a note with the principal due in 10 years and with interest payable annually or (2) to issue a note to repay $12,000 of the principal each year along with the annual interest based on the unpaid principal balance. Assume the interest rate is 8 percent for each option.
Required:
a. What amount of interest will Dodson pay in year 1
(1) Under option 1?
(2) Under option 2?
b. What amount of interest will Dodson pay in year 2
(1) Under option 1?
(2) Under option 2?
c. Explain the advantage of each option.