Ace Co. sold to King Co. a $20,000, 8% 5-year note that required five equal annual year-end payments. This notes was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:

8% 3.992
9% 3.890

What should be the total interest revenue earned by King on this note?

Answer is $5,560 computed as follows:

Annual payments $20,000 / 3.992 = $5,010
multiplied by 5 equal payments of principal and interest =
total payments of $25,050
Subtract discounted note $5,010 x 3.890 = $(19,490)
= Total interest over 5 years of $5,560

The part I don't get is why the question shouldn't be calculated like this:

$20,000/5 *3.992 =15,968

Minus: 4000*3.890 = 15,560

= 408

I know this might be totally off. I just don't know how come some questions in the previous chapters using annual payments as the base to calculate the PV of the Note while this one is exactly the opposite way.

Can someone help?

Thanks! Appreciate your kind help

Thanks for your reply!! I appreciate for your help!

I have another question that is similar to the one I posted:

Young Cor. purchased equiptment by making a down payment of $4000 and issuing a note payable for $18000. A payment of $6000 is to be made at the end of each year for three years. The applicable rate of interest is 8%. The present value of an ordinary annuity factor for 3 years at 8% is 2.58, and the present value for the future amount of a single sum of one dollar for 3 years at 8%is.735. What is the capitalized cost of the equipment?

Solution:

Down payment+Present value of note payable: 4000+6000x2.58 = 19480

In this question, how come you can't use $18000/2.58 to get the annual payment of 6977, like the question I posted ?

I am confused when I should get the annual payment. Is it if it's given then I just use it, otherwise, to get the annual payment first?

Thanks!