Inventory financing Heidelberg Cement faces a liquidity crisis: It needs a loan of €1,000,000 for two months. Having no source of additional unsecured borrowing, the firm must find a secured short-term lender. The firms’ accounts receivable are quite low, but its inventory is considered liquid and reasonably good collateral.

The book value of inventory is €2,000,000 of which €1,500,000 is finished goods. (Assume a 365-day year.)

(1) Deutsche Bank can make a €1,000,000 trust receipt loan against the finished goods inventory. The annual interest rate on the loan is 6% on the outstanding loan balance plus a 0.25% administration fee levied against the initial loan.

Because it will be liquidated as inventory is sold, the average amount owed over the month is expected to be €750,000.

(2) Erste Bank will lend €1,000,000 against a floating lien on the book value of inventory for the two-month period at an annual interest rate of 7%.

(3) Raiffeisen Bank will lend €1,000,000 against a warehouse receipt on the finished goods inventory and charge 8% annual interest on the outstanding loan balance.

Because the loan will be liquidated as inventory is sold, the average loan balance is expected to be €700,000.

a. Calculate the euro cost of each of the proposed plans for obtaining an initial loan amount of €1,000,000.

b. Which bank do you recommend to get the loan from and why?

c. If the firm had made a purchase of €1,000,000 for which it had been given terms of 2/10 net 60, would it increase the firm’s profitability to give up the discount and not borrow as recommended in part b? Explain your answer.