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Harper Engine Company needs $634,000 to take a cash discount of 2
Harper Engine Company needs $634,000 to take a cash discount of 2.50/10, net 90. A banker will loan the money for 80 days at an interest cost of $14,300.
a) What is the effective rate on the bank loan? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b) How much would it cost (in percentage terms) if Harper did not take the cash discount but paid the bill in 90 days instead of 10 days? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c) Should Harper borrow the money to take the discount?
multiple choice 1
- Yes
- No
d) If another banker requires a 10 percent compensating balance, how much must Harper borrow to end up with $634,000? (Round your answer to 2 decimal places.)
e-1) What would be the effective interest rate in part d if the interest charge for 80 days were $15,800? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
e-2) Should Harper borrow with the 10 percent compensating balance requirement? (There are no funds to count against the compensating balance requirement.)
multiple choice 2
- Yes
- No
Expert Solution
a) Computation of the effective rate on bank loan:-
Effective rate = ($14,300 / $634,000) * 360 / 80
= 0.022555 * 4.5
= 10.15%
b) Computation of the cost of lost discount:-
Cost of lost discount = (Discount/(1-Discount))*(360/(Maximum payable days-Discount period))
= (2.50%/(1-2.50%))*(360/(90-10))
= 0.02564 * 4.5
= 11.54%
c) Yes, Harper should borrow money because the cost of borrowing is lower than the cost of lost discount.
d) Computation of tye amount to be borrowed:-
Amount to be borrowed = $634,000 / (1 - 10%)
= $704,444.44
e-1) Computation of the effective interest rate:-
Effective interest rate = ($15,800/($704,444.44*(1-10%)))*(360/80)
= ($15,800/$634,000)*4.5
= 0.02492 * 4.5
= 11.21%
e-2) Yes, Harper should borrow 10% compensating balance because the cost of borrowing is lower than the cost of lost discount.
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