Permanent assets financing
Bingo Corporation is determining whether to support $150,000 of its permanent current assets with a bank note or a short-term bond. The firm's bank offers a two-year note where the firm will receive $150,000 and repay $175,000 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, Bingo can sell 8.5 percent coupon bonds with a 2-year maturity and $1,000 par value at a price of $973.97. How many percentage points lower is the interest rate on the less expensive debt instrument?
We calculate the interest rate on the two options -
1. Bank Note - Here we borrow $150,000 and repay $175,000 at the end of 2 years. Using the compound interest formula
175,000 = ...
The solution explains how to determine the interest rates on different borrowing alternatives