Question

Hand-to-Mouth (H2M) is currently cash-constrained, and must make a decision about whether to delay paying one of its suppliers, or take out a loan. They owe the supplier $12,000 with terms of 2.2/10 Net 40, so the supplier will give them a 2.2% discount if they pay by today (when the discount period expires). Alternatively, they can pay the full $12,000 in one month when the invoice is due. H2M is considering three options: Alternative A: Forgo the discount on its trade credit agreement, wait and pay the full $12,000 in one month. Alternative B: Borrow the money needed to pay its supplier today from Bank A, which has offered a one-month loan at an APR of 11.6%. The bank will require a (no-interest) compensating balance of 4.8% of the face value of the loan and will charge a $110 loan origination fee. Because H2M has no cash, it will need to borrow the funds to cover these additional amounts as well. Alternative C: Borrow the money needed to pay its supplier today from Bank B, which has offered a one-month loan at an APR of 14.9%. The loan has a 1.1% loan origination fee, which again H2M will need to borrow to cover.

A. The effective annual cost is

B. The effective annual cost is

c. The effective annual cost is

Round two decimals places.

Answer 1

A. Alternative A Effective Annual Cost = (1 + (Discount / Amount Payable after Discount))^12 - 1

Alternative A Effective Annual Cost = (1 + (264 / 12000-264))^12 - 1

Alternative A Effective Annual Cost = (1 + 0.02249)^12 - 1

Alternative A Effective Annual Cost = 30.60%

B. Alternative B Effective Annual Cost = (1 + ((Interest + Loan Origination Fee)/Loan Amount))^12 - 1

Alternative B Effective Annual Cost = (1 + ((12000+110)*11.6%/(0.952*12) + 110)/12000))^12 - 1

Alternative B Effective Annual Cost = (1 + 0.01941)^12 - 1

Alternative B Effective Annual Cost = 25.95%

C. Alternative C Effective Annual Cost = (1 + ((Interest + Loan Origination Fee)/Loan Amount))^12 - 1

Alternative C Effective Annual Cost = (1 + (((12000+132)*14.9%/12 + 132)/12000))^12 - 1

Alternative C Effective Annual Cost = (1 + 0.02355)^12 - 1

Alternative C Effective Annual Cost = 2.23%