On January 1, Year 1, The Palms borrowed $200,000 to purchase a warehouse by agreeing to an 8%, 5-year note with the bank. Payments of $50,091.29 are due at the end of each year. The first payment will be made on December 31, Year 1. What is the interest expense for Year 1 and Year 2, respectively? (Round your final answers to the nearest dollar.)

Question

Quizplus · Accepted Answer

To calculate the interest expense for Year 1, we need to find the interest on the outstanding balance of the loan. As of December 31, Year 1, the outstanding balance will be:
$200,000 - $50,091.29 = $149,908.71
Therefore, the interest expense for Year 1 will be:
$149,908.71 × 0.08 = $11,992.70, which rounds to $12,000.

To calculate the interest expense for Year 2, we need to find the interest on the outstanding balance of the loan as of December 31, Year 1. Using the same formula as above, we get:
$149,908.71 × 0.08 = $11,992.70 interest for Year 2, but this is only for a portion of the year. We need to add the interest for the full year on the new balance after the second payment is made. This balance will be:
$149,908.71 - $50,091.29 = $99,817.42
So the interest on this balance for the full year will be:
$99,817.42 × 0.08 = $7,985.39
Adding these two amounts together, we get a total interest expense for Year 2 of $19,977.09, which rounds to $20,000.

Therefore, the best answer is C.

On January 1, Year 1, the Palms Borrowed $200,000 to Purchase