Effective Rate and Bank Loans
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Please help with the following problem.
My company needs $300,000 to take a cash discount of 2/10, net 70. A bank will loan the money for 60 days at a total interest cost of $5,500.
a. What is the effective rate on the bank loan?
b. How much would it cost (as a percentage) I the company did not take the cash discount, but paid the bill in 70 days rather than 10 days?
c. Should the company borrow the money to take the discount?
d. If the banker requires 20% compensating balance, how must the firm borrow to end up with $300,000?
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Solution Summary
The solution explains how to calculate the effective rate of interest and evaluate the cost of a bank loan against the cost of not taking a cash discount. Step by step calculations are given for this solution.
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a. What is the effective rate on the bank loan?
The amount borrowed is 300,000. Interest is 5,500 for 60 days. Using the simple interest formula
Interest = Principal X Rate X Time
5,500=300,000 X Rate X 60/360
Rate = 11%
b. How much would it cost (as ...
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