Question

Neveready Flashlights Inc. needs $340,000 to take a cash discount of 3/17, net 72. A banker will loan the money for 55 days at an interest cost of $10,400.

a. What is the effective rate on the bank loan? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Effective rate of interest:

b. How much would it cost (in percentage terms) if the firm did not take the cash discount but paid the bill in 72 days instead of 17 days? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Cost of not taking a cash discount:

c. Should the firm borrow the money to take the discount?

Yes

No

d. If the banker requires a 20 percent compensating balance, how much must the firm borrow to end up with the $340,000?

Amount to be borrowed:

e-1. What would be the effective interest rate in part d if the interest charge for 55 days were $13,000? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Effective rate of interest:

e-2. Should the firm borrow with the 20 percent compensating balance requirement? (The firm has no funds to count against the compensating balance requirement.)

Yes

No

Answer 1

a. Effective rate of Interest = 10,400/340,000 *360/55 = 0.1835 = 0.1835 =18.35%

b. Cost of not taking a cash discount =3%/97% * 360/(72-17) = 0.2024 = 20.24%

c. Yes, becuase the cost of borrowing is less the the cost of losing the discount

d. Amount to be borrowed = 340,000/(1-0.2) = 425,000

e-1. Effective rate of Interest = 13,000/340000 * 360/55 = 0.2503 = 25.03%

e-2. No, do not borrow with a compensating balance of 20 percent since the effective rate is greater than the savings from taking the cash discount