Neveready Flashlights Inc. needs $300,000 to take a cash discount of 3/16, net 7

Question

Neveready Flashlights Inc. needs $300,000 to take a cash discount of 3/16, net 77. A banker will loan the money for 61 days at an interest cost of $14,900.  

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.)

How much would it cost (in percentage terms) if the firm did not take the cash discount but paid the bill in 77 days instead of 16 days? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Should the firm borrow the money to take the discount?

If the banker requires a 20 percent compensating balance, how much must the firm borrow to end up with the $300,000?

What would be the effective interest rate in part d if the interest charge for 61 days were $12,900? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Should the firm borrow with the 20 percent compensating balance requirement? (The firm has no funds to count against the compensating balance requirement.)

Explanation / Answer

Neveready Flashlights Inc. What is the effective rate on the bank loan? Effective rate of interest = (14900 / 300000 ) x 360/61 = 29.33% How much would it cost (in percentage terms) if the firm did not take the cash discount but paid the bill in 77 days instead of 16 days? Cost of lost discount = (3%/97%) x ( 360 / (77-16) = 18.25% Should the firm borrow the money to take the discount? Yes, because the cost of borrowing is less than the cost of losing the discount. If the banker requires a 20 percent compensating balance, how much must the firm borrow to end up with the $300,000? (300000/0.8)= 375000 What would be the effective interest rate in part d if the interest charge for 61 days were $12,900? Should the firm borrow with the 20 percent compensating balance requirement? Effective interest rate = ( 12900 / ( 375000 -75000 ) ) x 360/61 = 25.38%

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