Question

Biochemical Corp. requires $720,000 in financing over the next three years. The firm can borrow the funds for three years at 10.20 percent interest per year. The CEO decides to do a forecast and predicts that if she utilizes short-term financing instead, she will pay 8.50 percent interest in the first year, 12.90 percent interest in the second year, and 9.75 percent interest in the third year. Assume interest is paid in full at the end of each year.
Required:
a. Determine the total interest cost under each plan.
b. Which plan is less costly?

i. Short-tem variable-rate plan
ii. Long-term fixed-rate plarn

Answer 1

Answer:

Long-term fixed-rate plan-$220,320.00  

Short-term variable-rate plan-$224,280.00  

The long-term fixed-rate plan is less costly as it has a lower interest expense

Explanation:

Total interest under the first plan=principal amount*interest rate*3 years

principal amount is $720,000

interest rate is 10.20%

total interest expense=$720,000*10.20%*3=$220,320.00  

Interest expense under second plan=($720,000*8.50%)+($720,000*12.90%)+($720,000*9.75%)=$224,280.00