Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is $420,000. The company can borrow $420,000 for three years at 12 percent annual interest or for one year at 10 percent annual interest. Assume interest is paid in full at the end of each year.

a. How much would Sauer Food Company save in interest over the three-year life of the computer system if the one-year loan is utilized and the loan is rolled over (reborrowed) each year at the same 10 percent rate? Compare this to the 12 percent three-year loan.

10 percent loan

12 percent loan

Interest savings

b. What if interest rates on the 10 percent loan go up to 15 percent in year 2 and 18 percent in year 3? What would be the total interest cost compared to the 12 percent, three-year loan? Fixed-rate 12% loan

Variable-rate loan

Additional interest cost