Question

On January 1, 2018, Red, Inc. borrowed cash by issuing a $500,000, 5-year note that specified 6% interest to be paid on December 31 of each year and the $500,000 to be paid at maturity. If the note had instead been an installment note to be paid in four equal payments at the end of each year beginning December 31, 2018, which of the following would be true?

The annual cash payment would have been less.

The first year's interest expense would have been higher.

The second year's interest expense would have been less.

The effective interest rate would have been higher.

Answer 1

The second year's interest expense would have been less.

Step-by-step explanation:

After paying the first installment, the outstanding payable balance would be $500000, therefore the the interest in the second year would be lower than $30000

If the annual cash payment would have been less, the amount paid under instalment would include interest payment and the repayment principle which would have been more than $30000 of interest expense

If the first year's interest expense would have been higher under both the methods, the amount outstanding at the beginning for interest calculation would be $500000 and interest at 6% would have been same for first year

Lastly, the effective interest rate would have been lower