Question
Hand-to-Mouth (H2M) is currently cash-constrained, and must make a decision about whether to delay paying one of its suppliers, or take out a loan. They
Hand-to-Mouth (H2M) is currently cash-constrained, and must make a decision about whether to delay paying one of its suppliers, or take out a loan. They owe the supplier $10,500 with terms of 2.4/10 Net 40, so the supplier will give them a 2.4% discount if they pay by today (when the discount period expires). Alternatively, they can pay the full $10,500 in one month when the invoice is due. H2M is considering three options:
Alternative A: Forgo the discount on its trade credit agreement, wait and pay the full $10,500 in one month.
Alternative B: Borrow the money needed to pay its supplier today from Bank A, which has offered a one-month loan at an APR of 11.9%. The bank will require a (no-interest) compensating balance of 5.3% of the face value of the loan and will charge a $110 loan origination fee. Because H2M has no cash, it will need to borrow the funds to cover these additional amounts as well.
Alternative C: Borrow the money needed to pay its supplier today from Bank B, which has offered a one-month loan at an APR of 14.6%. The loan has a 0.6% loan origination fee, which again H2M will need to borrow to cover.
Alternative A:
The effective annual cost is (Round to two decimal places.)
Alternative B:
The effective annual rate is (Round to two decimal places.)
Alternative C:
The effective annual rate is (Round to two decimal places.)
(Select the best choice below.)
A.
Alternative
Upper BB,
with the lowest effective annual rate, is the best option for Hand-to-Mouth.
B.
Alternative
Upper AA,
with the lowest effective annual rate, is the best option for Hand-to-Mouth.
C.
Alternative
Upper CC,
with the lowest effective annual rate, is the best option for Hand-to-Mouth.
D.All the alternatives are equivalent.
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