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Biochemical Corp. requires $660,000 in financing over the next three years. The firm can borrow the funds for three years at 12.80% interest per year. The CEO decides to do a forecast and predicts that if she utilizes short-term financing instead, she will pay 9.50% interest in the first year, 14.25% interest in the second year, and 10.75% 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.
B. Which plan is less costly?

Respuesta :

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Answer:

A. Fixed Cost Financing = $253,440

Short-term Financing=$227,700

B. Short term financing is less costly

Explanation:

A. Calculation to Determine the total interest cost under each plan.

Cost of Three Year FIXED COST FINANCING

$660,000 borrowed × 12.80% per annum × 3 years

= $253,440

Cost of Three Year Variable SHORT-TERM FINANCING

1st year $660,000 × 9.50%

Per annum= $ 62,700 Interest cost

2nd year $660,000 × 14.25%

Per annum=94,050 Interest cost

3rd year $660,000 × 10.75%

Per annum=70,950 Interest cost

TOTAL

YEAR 1 $ 62,700 Interest cost

YEAR 2 $94,050 Interest cost

YEAR 3 70,950 Interest cost

=$227,700

B. Based on the above calculation the SHORT TERM plan is less costly because the total interest cost for three years is $227,700 which is lesser than Fixed term the total interest cost of $253,440

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