Neveready Flashlights inc. needs $375,000 to take a cash discount of 2/13, net 7

Question

Neveready Flashlights inc. needs $375,000 to take a cash discount of 2/13, net 74. A banker will loan the money for 61 days at an interest cost of $10,800 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.). Effective rate of interest % How much would it cost (in percentage terms) if the firm did not take the cash discount but paid the bill in 74 days instead of 13 days? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of not taking a cash discount % Should the firm borrow the money to take the discount? Yes or No? If the banker requires a 20 percent compensating balance, how much must the firm borrow to end up with the $375,000? Amount to be borrowed % What would be the effective interest rate in part d if the interest charge for 61 days were $14,400? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Effective rate of interest % Should the firm borrow with the 20 percent compensating balance requirement? (The firm has no funds to count against the compensating balance requirement.) Yes or No?

Explanation / Answer

a)effective rate of loan=(1+10800/375000)^(360/61)-1=0.1824=18.24%

b)cost=(1+.02/.98)^(360/61)-1=.1266=12.66%

c)No the firm must not borrow to take the discount since the cost of borrowing 18.24% is greater than the cost of not taking the discount 12.66%.

d)Let x be the amount borrowed.

20% of x is compensating balance while the 80% of x is the actual money taken out as loan=375000

=> Amount to be borrowed x=375000/.8=468750

so that the 20% of 468750=93750 is used as compensating balance while 468750-93750 =375000 is actually the amount that is borrowed.

Thus Amount to be borrowed is $ 468,750

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