Capital investment is fundamental for any organisation to help in promoting the effectiveness of its operations. However, the investment usually requires a lot of capital. Therefore, organisations have to find ways of raising adequate monies for that purpose. Jay-Hyung et al. (2020) state that capital funds can be raised in various ways preferable to the organisation. Loans are a basic way of obtaining funds from various lending institutions.
There are different types of loans depending on how the loans are structured. Mainly interest charged and mode of principal repayment are the key factors. In this case, funds borrowed under a standard loan are repaid every month for a fixed period plus the interest charged on the loan. The borrower makes fixed monthly repayments of principal and the interest over a determined period. According to Michael and Brigham (2016), under a discounted loan, the loaned is expected to pay the entire sum lent but receives a discounted amount after deducting the interest payable and other costs. A discounted loan’s effective rate would be the sum of interest paid expressed as a percentage of the balance after one-year period.
A standard loan and the discounted loan both have their benefits and disadvantages. The main advantage of the former is that the borrower can make some savings on the interest charged. To achieve the saving, the loaned can choose to increase the monthly repayments (Jay-Hyung et al. 2020). The increase will translate to a shorter period of paying back the loan, therefore the loan is paid faster. The interest paid within the short period will be less compared to if the borrower is to repay over a longer period. Moreover, the loaned is allowed to choose the period of repayment depending on their ability to raise the expected monthly repayments. If a person fails to choose the repayment time, the financier usually has a ready standard repayment plan to offer.
The main advantage of the discounted loan is that it is paid in equal monthly repayments throughout the term of the loan. This gives the borrower a fixed figure that they are certain they will be required to pay at the end of each month (Michael & Brigham, 2016). Therefore, it facilitates easy planning early on and gives the lender a definite amount to expect. The loan can also be paid once as a lump sum upon maturity making it a preferable option over the short-term.
The standard loan would be the best option the Chief Executive Officer (CEO) should consider. The CEO can repay the sum of $100,000 through structured monthly repayments over the period that the CEO would consider appropriate. The loan amount is high and may be a challenge for the CEO to raise the entire sum at once. Even if the sum borrowed is $95,000, the standard loan approach would still be better. If the repayment period is maintained, the monthly repayment will also come down. Therefore, the CEO can opt to shorten the repayment period over which the company will save some money on interest paid. Capital budgeting is an expensive undertaking that cannot be solely funded by the business without external support. To undertake a capital project worth $100000, the CEO must seek help in form of a standard loan that can be repaid over a preferred period.
References
Jay-Hyung, K., Fallov, J.A., & Groom, S. (2020). Upgrading capital budgeting practices. Journal of Capital Finance, 8(45) 130-344.
Michael, E.C., & Brigham, E.F (2016). Financial management: theory & practice. 3rd edition. Cengage learning.