Question

A borrower has two alternatives for a loan: (1) issue a $720,000, 120-day, 6% note or (2) issue a $720,000, 120-day note that the creditor discounts at 6%. 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) $720,000, 120-day, 6% simple-interest	$_______________
(2) $720,000, 120-day note discounted at 6%	$________________

Answer 1

Solution a:

Option 1: Issue a $720,000, 120-day, 6% note

Interest expense = $720,000 * 6% * 120/360 = $14,400

Option 2: Issue a $720,000, 120-day note that the creditor discounts at 6%

Discount rate for 120 days = 6%*120/360 = 2%

Net Proceeds =Present value of $720,000 discounted at 2% = $720,000 / 1.02 = $705,882

Interest Expense = $720,000 - $705,882 = $14,118

Solution b:

Proceeds received by borrower :

Option 1: $720,000, 120-day, 6% simple-interest = $720,000

Option 2: $720,000, 120-day note discounted at 6% = $705,882