E4:6

Biochemical Corp. requires $510,000 in financing over the next three years. The firm can borrow the funds for three years at 10.80 percent interest per year. The CEO decides to do forecast and predicts that if she utilizes short-term financing instead, she will pay 7.50 percent interest in the first year, 12.15 percent interest in the second year, and 8.25 percent interest in the third year. Assume interest is paid in full at the end of each year.

a.Determine the total interest cost under each plan.

Interest CostLong-term fixed-rate$Short-term variable-rate$

b.Which plan is less costly?Short-term variable-rate plan or Long-term fixed-rate plan