Estimate the interest rate paid on a commercial bank loan, commercial paper, and

Question

Estimate the interest rate paid on a commercial bank loan, commercial paper, and trade credit Explain why trade credit is a source of credit for many firms while commercial paper is a source for larger, credit-worthy companies Illustrate how pledging an asset may be used as a source of short-term financing Identify why factoring may be an expensive source of funds Firm A borrows $1 million from a commercial back. The bank charges an annual rate of 10 percent and requires a 3 percent origination fee. How much does the firm have to borrow to have $1 million? Confirm your answer and determine the effective rate of interest. (Assume the loan is outstanding for one year.) Tinker, Inc. finances its seasonal working capital need with short term bank loans. Management plans to borrow $65,000 for a year. The bank has offered the company a 3.5 percent discounted loan with a 1.5 percent origination fee. What are the interest payment and the origination fee required by the loan? What is the rate of interest charged by the bank? You can borrow $5,000 for 60 days with an interest payment of $125. What is the simple rate of interest? What is the compound rate of interest? Stella & Chloe, Inc. needs to borrow $2,000,000 for six months. It can sell 180-day commercial paper with a face value of $2,000,000 for $1,900,000 or borrow the money from a commercial bank at 10 percent. In both cases the interest is $100,000. Which loan is more expensive and why? An individual wishes to borrow $10,000 for a year and is offered the following alternatives: a 10 percent loan discounted in avarice an 11 percent straight loan (i.e., interest paid at maturity). Which loan is more expensive? Which of the following terms of trade credit is the more expensive? A 3 percent cash discount if paid on the 15th day with bill due on the 45th day (3/15, net 45) A 2 percent cash discount if paid on the 10th day with the bill due on the 30th day (2/10, net 30) Trade credit may be stated as n60 plus 18 percent on the balance outstanding after two months. What is the cost of this credit? Dash Construction needs to borrow $200,000 for 45 days in order to take advantage of the cash discount of 3/10, n55 offered by a supplier. Dash Construction can borrow the funds from a bank with an interest payment of $5,000 at the maturity of the loan. Should management borrow the funds from the bank to take advantage of the discount?

Explanation / Answer

First method

a $10000 borrowed for 1 year at 10% loan discount in advance
Interest = $10000* 0.10 *1= $1000

b $10000 borrowed for 1 year at 11% loan interest paid at maturity
Interest = $10000 * 0.11* 1 = $1100
Present value of $1100 = $1100/(1+.11) = $900
A 10% loan discounted in advance will be expensive.

Second method

(A) Interest Rate for option A= ($10,000 x 10%) / ($10,000 x 90%) = $1000/$9000 = 11.11%

(B) Interest Rate for option B = 11%

Therefore, Option A is more expensive.

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