Question

16

Neveready Flashlights Inc. needs $345,000 to take a cash discount of 3/13, net 73. A banker will loan the money for 60 days at an interest cost of $12,300.  

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.)
  

b. How much would it cost (in percentage terms) if the firm did not take the cash discount but paid the bill in 73 days instead of 13 days? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
  

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

	No
	Yes

  
d. If the banker requires a 20 percent compensating balance, how much must the firm borrow to end up with the $345,000?
  

  
e-1. What would be the effective interest rate in part d if the interest charge for 60 days were $11,800? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
  

  
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 = 12300/345000 * 360 /60

= 21.39%

b)

Cost of lost discount = 3% / 97% * 360/(73 - 13)

= 18.56 %

c)

No, because the cost of borrowing is more than the cost of losing the discount.

d)

Amount needed to be borrowed

= $345000 / (1 - c)

= $345000 / (1 - 0.20)

= $431250

e)

Effective interest rate = 11800 / (431250 - 86250) * 360/60

= 20.52 %

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