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This Lesson (Corporate Finance: Amortization - Basics) was created by by Shruti_Mishra(0)
   : View Source, ShowAbout Shruti_Mishra: I am a maths graduate from India and am currently persuing masters in Operations Research.
Amortization can be defined for two separate things: 1. Loans and Financing: Paying off a loan/debt as regular installments over a period of time. 2. Intangible Assets: The capital expenditure used in building up intangible assets like patents/copyrights/goodwill etc. is amortized over a specific period of time. In loan amortization, usually the total money paid remains constant per period, but the components of the payment vary between the principal repayment and the interest paid. Initially the interest component is higher, but gradually as the net loan decreases, the interest component decreases and the principal repayment increases. The difference between depreciation and amortization is that depreciation is used for tangible assets while amortization is used for intangible assets or loans. These terms are often used interchangeably, but it is incorrect technically. Example 1: Suppose a medical firm spent $10,000 on developing a patented equipment and that the equipment lasts for 20 years. The firm will thus amortize the expenditure by $500 every year as an expense. Loan amortization can also be seen as present value of an annuity with discount rate as the interest rate. Thus for a loan of $10,000 for 5 years at 10% interest rate, the cash flow per year should be such that the present value of the cash flow, discounted at 10% should be equal to $10,000. Thus the annuity formula can be applied here to get the amount payable per year. Thus the formula for calculating the payment per period becomes where C is the payment amount per period, T is the number of time periods, r is the interest rate per time period and PV is the initial loan amount. Also see: Depreciation This lesson has been accessed 10650 times. |
