(Short Term Financing)

Jati Bhd. needs RM150,000, 150 days financing for its short term project. The management has identified four (4) suitable financings for the project as follows:

Alternative 1

Forego trade credit with the following terms: 2/10, net 50.

Alternative 2

Issue commercial paper at 15 percent annual interest rate with floatation cost of RM3,000 per paper. The face value of each paper is RM50,000.

Alternative 3

A discounted loan at an interest rate of 12 percent and compensating balance of 2 percent. Currently, Jati Bhd has a current account balance of RM1,500 in the bank.

Alternative 4

Jati Bhd has a revolving credit agreement amounting to RM300,000. The commitment fee on the unused loan portion is 2.5 percent. The annual rate on the loan is 10 percent and there is a compensating balance requirement of 15 percent on the unused loan amount.

i) Calculate the effective interest rate for alternative 1, 2, 3 and 4.

ii) Which is the best alternative for Jati Bhd? Why?