Delta Industries buys on terms of 2/10, net 40. The firm purchases $1,080,000 net in materials per year. (Use 360 days a year.)

1. How much costly trade credit does the firm use on average each year?

2. What is the effective annual cost of not taking the discount?

Now, suppose Delta Industries needs to raise $100,000 for 1 year to supply working capital for a new project. Delta Industries is negotiating with First City Bank for this 1-year loan. First City Bank has offered Delta Industries the following four alternatives.

• A 10% annual rate on simple interest loan, with no compensating balance required and interest due at the end of the year.

• A 9% annual rate on a discounted loan.

• A 8% annual rate on a discounted loan, with a 20 percent compensating balance required.

• An add-on interest of 7 percent on a 12-month installment loan.

3. Calculate the effective annual rate for each of the four alternatives provided by bank.

4. Which alternative should Delta Industries go with?