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Biochemical Corp. requires $500,000 in financing over the next three years.

The firm can borrow the funds for three years at 10.60 percent interest per year. The CEO decides to do a forecast and predicts that if she utilizes short-term financing instead, she will pay 7.25 percent interest in the first year, 11.90 percent interest in the second year, and 8.15 percent interest in the third year. Determine the total interest cost under each plan. Which plan is less costly?

Solution: Biochemical Corp. Cost of Three Year Fixed Cost Financing $500,000 borrowed 10.60% per annum 3 years = $159,000 Cost of Three Year Variable Short-term Financing 1st year $500,000 7.25% Per annum = $ 36,250 Interest cost 2nd year $500,000 11.90% Per annum = 59,500 Interest cost 3rd year $500,000 8.15% Per annum = 40,750 Interest cost $136,500 3-year total The short-term plan is less costly.

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