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 12%. The bank will require a (no-interest) compensating balance of 5.3% of the face value of the loan and will charge a $100 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 15.4%. The loan has a 1% loan origination fee, which again H2M will need to borrow to cover.
Find the effective annual cost of Alternative A, and find the effective annual rate for Alternative B & C. Which alternative is the cheapest source of financing for Hand-to-Mouth?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started