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Rapier Fencing requires $750,000 in financing for a 60?day period
Rapier Fencing requires $750,000 in financing for a 60?day period. Three alternatives are being considered.
a. Establish a line of credit with the bank at an interest rate of 6 percent payable on a discounted basis.
b. Forgo trade discounts from suppliers on terms of 1.5/10, net 70.
c. Issue commercial paper for 60 days sold at a discounted price of 98.8 percent of maturity value.
a. What would be the rate of interest for bank loan? (Use 365 days in a year. Do not round intermediate calculations. Round the final answer to 2 decimal places.)
Rate of Interest for bank loan %
b. What would be the cost of forgoing the cash discount? (Use 365 days in a year. Do not round intermediate calculations. Round the final answer to 2 decimal places.)
Cost of forgoing the cash discount %
c. What would be the cost of commercial paper? (Use 365 days in a year. Do not round intermediate calculations. Round the final answer to 2 decimal places.)
Discounted commercial paper %
d. Which alternative should be selected?
- Bank loan
- Cost of forgoing discount
- Commerical paper
Expert Solution
a. Computation of Rate of Interest for Bank Loan:
Financing Required = $750,000
Interest Rate = 6%
Interest on Loan = $750,000*6%*60/365 = $7,397.26
Net Loan Amount = $750,000 - $7,397.26 = $742,602.74
Rate of Interest for Bank Loan = (1+$7,397.26/$742,602.74)^(365/60) -1
= (1.009961)^(365/60) - 1
Rate of Interest for Bank Loan = 6.22%
b. Computation of Cost of Foregoing the Cash Discount:
Cost of Foregoing the Cash Discount = (1+(Discount/(1-Discount)) ^(365/(Final Date - Early Date))) - 1
= (1+(1.5%/(1-1.5%))^(365/(70-10))) - 1
= (1+(0.0152))^(365/(70-10))) - 1
= 1.0963 -1
Cost of Foregoing the Cash Discount = 9.63%
c. Computation of Cost of Commercial Paper:
Maturity Value = $750,000*98.8% = $741,000
Discount = $750,000 - $741,000 = $9,000
Cost of Commercial Paper = 1+($9,000/$741,000)^(365/60) - 1 = 7.62%
d. Bank loan should be selected because its cost is less than other alternatives.
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