Neveready Flashlights Inc. needs $351,000 to take a cash discount of 3/18, net 7

Question

Neveready Flashlights Inc. needs $351,000 to take a cash discount of 3/18, net 75. A banker will loan the money for 57 days at an interest cost of $12,200.

A) What is the effective rate on the bank loan?

B) How much would it cost (in percentage terms) if the firm did not take the cash discount but paid the bill in 75 days instead of 18 days?

C) If the banker requires a 20 percent compensating balance, how much must the firm borrow to end up with the $351,000?

D) What would be the effective interest rate in part d if the interest charge for 57 days were $7,200?

Explanation / Answer

Effective Annual Rate EAR = (1 + periodic rate)^N – 1 Peridic rate =18.83/12 =1.57% monthly Periods per year=12 Bank Loan Amt                              351,000 Interest amt                                12,200 Interest period in days                                        57 Interest rate for 57 days = 3.48% Periods in a year =365/57 =                                     6.40 EAR =(1.0348)^6.4-1 = 24.47% A So EAR of Bank Loan =24.47% B Cost of losing credit Term = 3/18,n75 Periodica rate =3/97=3.093% Periods in a year =365/(75-18)=                                     6.40 EAR=(1.03093)^6.4-1= 21.53% So By not taking credit the cost of firm would be 21.53% C If Compensating Balance is 20% , The firm needs to Borrow 351000/0.80=$438750 to end up with $351000 after maniatning 20% min balance D If interset cahrged is 7200 Bank Loan Amt                              351,000 Interest amt                                  7,200 Interest period in days                                        57 Interest rate for 57 days = 2.05% Periods in a year =365/57 =                                     6.40 EAR =(1.0205)^6.4-1 = 13.87% So EAR of Bank Loan =13.87% in this case

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