Short term financing with Bank Loans
The Hand-to-Mouth Company needs $10,000 loan for the next 90 days. It is trying to decide which of the three alternatives to use:
Alternative A: Forgo the discount on its trade credit agreement that offers terms of 2/10, net 30.
Alternative B: Borrow the money from Bank A, which has offered to lend the firm $10,000 for 30 days at an APR of 12%. The bank will require a (no-interest) compensating balance of 5% of the face value of the loan and will charge a $100 loan origination fee, which means Hand-to Mouth must borrow more than $10,000.
Alternative C: Borrow the money from Bank B, which has offered to lend the form $10,000 for 30 days at an APR of 15%. The loan has a 1% origination fee.
Which alternative is the cheapest source of financing for Hand-to-Mouth?
Alternative A : We calculate the cost of foregoing the cash discount. The nominal annual cost of not taking the cash discount is
Nominal annual cost = % discount/(100-% discount) X 365/(Credit period - discount ...
The solution explains how to determine the cheapest source of financing from the given alternatives