How many percentage points lower is the interest rate on the less expensive debt instrument?
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ABC 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.l Alternatively, ABC can sell 8.5% 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?
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Solution Summary
The solution explains how to calculate the interest rate on debt, with step by step calculations and the answer.
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We need to find out the interest rate on the two options.
Option 1 - Bank note - Here the amount borrowed in 150,000 and the amount repaid is 175,000 in 2 years. The difference is the interest that is paid. So over 2 years we pay 25,000 as interest. The compound interest formula is:
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