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Liquidation of loan or loan amortization can be done by the annuity method.

Equal installment needed to be made to payoff loan over a defined period of time. Reduced balance method is calculated and interest is calculated on the principal amount outstanding. example Xyz supermarket has decided to open a new store and the cost estimated for the initial investment was AED 2,00,00 and a bank is ready to finance the amount with 10 percentage of interest for a 5 years period. Calculate the fixed repayment amount and prepare a loan amortisation schedule. The firm has same amount as free reserve which can be invested in some other business which has earn 9 percentages opportunity cost for a period of 5 years. The finance manager asked to make a good decision on both opportunities. First the fixed repayment amount has to be calculated. PVA= PMT(PVIFA) AED 2,00,00= PMT 3.791 PMT =AED 2,00,000/3.791 = AED 52756.5 THE FIXED REPAYMENT IS = AED 52756 NOW THE LOAN AMORTISATION SCHEDULE CAN BE MADE. End of year 0 1 2 3 4 5 Repayment amount AED ------------52,756 52,756 52,756 52,756 52,756 Interest amount AED -------------20,000 16,724 13,121 9,157 4,978 Principal amount -AED ------------32,756 36,032 39,635 43,599 47,960 Outstanding balance AED 2,00,000 1,67,244 1,31,212 91,577 47,978 47,778 200

The difference of AED 200 occurred because of small variation in the repayment amount adjusted i.e. AED 52,756.5 is adjusted to AED 52,756 for easy calculation. Interest is calculated on reducing balance method by finding it based on outstanding balance. Principal amount is calculated by deducting interest amount from the repayment amount. MI

The firm has two investment opportunities. The firm has only investment amount to start any one of the project. The firm can either use its free reserve for the first project or avoid loan from the bank. The free reserve can be utilized for the second investment purpose it is viable. The future value of AED 2, 00,000 would be n FV= PV( 1+r) 5 FV= AED 2,00,000(1+.09) = AED 2,00,000 * 1.53 = AED 3,077,25 The firm will find its amount invested in the second project is grown up to AED 3,077,25 In the first incident for the amount of AED 2,00,000 the company pays only AED 2,63,980 which is inclusive of the interest amount paid to the bank. The finance manager can advice the company to use the loan facility for the first project and use its reserve amount to be invested in the second project. RISK AND RETURN Every financial decision contains an element of risk and return. The relation ship between these exists in the form of risk-return trade off. This means it is only possible to earn higher returns by accepting higher risk. In other words risk and return are positively correlated i.e. an increase in one is accompanied by an increase in other. The risk- and return trade off is central to investment decision making. One way to reduce risk is through diversification of business or in other words investment is done in collection of projects known as portfolio.

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