There are three alternatives to increase a net working capital of $10,000: (a) Forgo cash discounts with

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There are three alternatives to increase a net working capital of $10,000:

(a) Forgo cash discounts with the terms of 2/10, net 40.

(b) Borrow the money at 7 percent from the bank. This bank loan requires a minimum compensating balance of 20 percent and interest on the loan is paid at maturity.

(c) Sell commercial paper at 8 percent. The underwriting fees of the issue are 2 percent of the face value.

Calculate the effective annual cost of each of the above alternatives.

(d) Which alternative should be chosen and why?

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