Question

Harper Corporation needs €750,000 to take a cash discount of 5/15, net 40. A banker will loan the money for 25 days at an interest cost of €19,100. Assume a 360-day year for your calculations.

Instructions:

1. What is the effective rate on the bank loan? (5 points)
2. How much would it cost (in percentage terms) if Harper did not take the cash discount, but paid the bill in 40 days instead of 15 days? (5 points)
3. Should Harper borrow the money to take the discount? Explain. (5 points)
4. If another banker requires a 20 percent compensating balance, how much must Harper borrow to end up with €750,000? (5 points)
5. What would be the effective interest rate in part d if the interest charge for 25 days were €13,300? Since there are no funds to count against the compensating balance requirement, should Harper borrow with the 20 percent compensating balance? (5 points)

Answer 1

a]	Effective cost of bank loan = (1+19100/750000)^(360/25)-1 =	43.64%
b]	Effective cost of not taking discount = (1+5/95)^(360/25)-1 =	109.31%
c]	Yes, Harper should borrow the money at an effective cost of
	43.64% to take advantage of the discount, which discount
	has an opportunity cost of 109.31%.
d]	Harper must borrow 750000/(1-20%) =	€        937,500
e]	Effective cost = (1+13300/750000)^(360/25)-1 =	28.80%
	Yes, the Harper should borrow with 20% compensating balance.

answered by: anonymous