A bank offers a client a choice between two financing options over a one-year period:

Option 1: a bullet loan for the full year of £500,000 to be repaid at end year with interest fixed at 12 per cent p.a.

Option 2: An overdraft, with a quoted rate of 14 per cent p.a., with interest charged quarterly on the average balance.

The firm expects to need finance of £400,000 in the first quarter, £500,000 in quarter 2, £500,000 in quarter 3 and only £200,000 in the final quarter due to the seasonal nature of its business. (These are all quarterly averages.)

Unused funds can be invested at 2 per cent per quarter. The bank will not charge interest on accumulated quarterly interest charges.

(a) What advice would you give?

(b) What is the break-even rate on the overdraft, assuming the interest rate on the loan is fixed at 12 per cent?