Question

A borrower has two alternatives for a loan: (1) issue a $300,000, 120-day, 8% note or (2) issue a $300,000, 120-day note that the creditor discounts at 8%. Assume a 360-day year.

a. Calculate the amount of the interest expense for each option.
$ for each alternative.

b. Determine the proceeds received by the borrower in each situation.

(1) $300,000, 120-day, 8% interest-bearing note	$
(2) $300,000, 120-day note discounted at 8%	$

c.  Alternative   is more favorable to the borrower because the borrower   .

Answer 1

Answer:

(a)

Amount of the interest expense             = Amount issued x rate x period             =   $ 300,000 x 8% x 120 / 360                           =    $ 8,000

(b)

Proceeds received by borrower

Situation (1) :    - $ 300,000

Situation (2) : - $ 300,000 (-) $ 8,000   =    $ 292,000

c)

Alternative 1 is more favorable to borrower because borrower gets more proceeds from Alternative 1.