Question

The Hand-to-Mouth company needs a $10,000 loan for the next 30 days. It is trying to decide which of three alternatives to use:

Alternative A: Forgo the discount on its trade credit agreement that offers terms of 2/10, Net 30.

Alternative B: Borrow the money from Bank A, which has offered to lend the firm $10,000 for 30 days at an APR of 12%. The bank will require a (no-interest) compensating balance of 5% of the face value of the loan and will charge a $100 loan origination fee, which means Hand-to-Mouth must borrow even more than the $10,000.

Alternative C: Borrow the money from Bank B, which has offered to lend the firm $10,000 for 30 days at an APR of 15%. The loan has a 1% loan origination fee.

WHICH ALTERNATIVE IS THE CHEAPEST SOURCE OF FINANCING FOR HAND-TO-MOUTH?

Answer 1

Alternative A:

Forgoing the discount on its trade credit agreement.

The cost of Forgoing will be = 10000*2% = $ 200

Alternative B:

The bank needs 5% compensating balance. That means 10000*5% = 500

The company need to borrow $ 10,500 loan inoder for the 5% compensating balance.

Interest Cost = 10,500*12%*30/360 = $105

Loan origination fees = $100

Total cost =$205

Alternative C:

Interest Cost = 10,000*15%*30/360 = $125

Loan origination fees(10000*1%) = $100

Total Cost = $225

Therefore, Alternative A Forgoing the discount on its trade credit agreement is to Preferred as it has less cost.