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Chapter 3: Q7BP (page 185)

Boatler Used Cadillac Co. requires $850,000 in financing over the next two years. The firm can borrow the funds for two years at 12 percent interest per year. Mr. Boatler decides to do forecasting and predicts that if he utilizes short term financing instead, he will pay 7.75 percent interest in the first year and 13.55 percent interest in the second year. Determine the total two-year interest cost under each plan. Which plan is less costly?

Short Answer

Expert verified

The short-term financing plan, $181,050, is a less costly financing option for the company as the other option has the total cost of financing at $204,000.

Step by step solution

01

Information given in the question

The following information is provided:

Financing required in next two years = $850,000

Cost of financing = 12% per annum

The interest rate on short-term financing in the first year = 7.75% per annum

The interest rate on short-term financing in the second year = 13.55% per annum

02

 Cost of financing at 12% p.a. interest rate

The cost of financing is $204,000.

CostofFinancing=Borrowedfunds×Interestrate×Time=$850,000×$12%p.a×2=$204,000

03

Cost of financing using short-term financing

The cost of financing is $181,050.

CostofFinancing=Borrowedfunds×Interestrate×Time=($850,000×$7.75%p.a×1)+($850,000×$13.55%p.a×1)=$181,050

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Most popular questions from this chapter

Postal Express has outlets throughout the world. It also keeps funds for transactions purposes in many foreign countries. Assume in 2010 it held 240,000 reals in Brazil worth 170,000 dollars. It drew 12 percent interest, but the Brazilian real declined 24 percent against the dollar.

a. What is the value of its holdings, based on U.S. dollars, at year-end? (Hint: Multiply $170,000 times 1.12 and then multiply the resulting value by 76 percent.)

What is the prime interest rate? How does the average bank customer fare in regard to the prime interest rate?

What are three quantitative measures that can be applied to the collection policy of the firm?

What is an asset-backed public offering?

Neon Light Company of Kansas City ships lamps and lighting appliances throughout the country. Ms. Neon has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by three days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Florida.

a. If Neon Light Company has \(2.25 million per day in collections and \)1.05 million per day in disbursements, how many dollars will the cash management system free up?

b. If Neon Light Company can earn 6 percent per annum on freed-up funds, how much will the income be?

c. If the total cost of the new system is $400,000, should it be implemented?
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