Biochemical Corp. requires $660,000 in financing over the next three years. The

Question

Biochemical Corp. requires $660,000 in financing over the next three years. The firm can borrow the funds for three years at 12.80 percent interest per year. The CEO decides to do a forecast and predicts that if she utilizes short-term financing instead, she will pay 9.50 percent interest in the first year, 14.25 percent interest in the second year, and 10.75 percent interest in the third year. Assume interest is paid in full at the end of each year. a. Determine the total interest cost under each plan.

Explanation / Answer

Cost of three year fixed cost financing = $ 660,000 x 12.80 % x 3 = $ 660,000 x 0.1280 x 3 = $ 239,184

Cost of three year variable short term financing:

1st year $ 660,000 x 9.5 % = $ 660,000 x 0.095 =$ 62,700

2nd year $ 660,000 x 14.25 % = $ 660,000 x 0.1425 = $ 94,050

3rd year $ 660,000 x 10.75 % = $ 660,000 x 0.1075 = $ 70,950

                                                         Total cost = $ 227,700

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