Question

Taggart Transcontinental needs a $100,000 loan for the next 30 days. Taggart has three alternatives available:

Alternative #1: Forgo the discount on its trade credit agreement that offers terms of 2/5 net 35.

Alternative #2: Borrow the money from Bank A, which has offered to lead the firm $100,000 for one month at an APR of 9%. The bank will require a (no-interest) compensating balance of 10% of the face-value of the loan and will charge a $200 loan origination fee, which means that Taggart must borrow even more than the $100,000 they need.

Alternative #3: Borrow the money from Bank B, which has offered to lend the firm $100,000 for one month at an APR of 12%. The loan has a 1% origination fee.

1. What is the effective annual rate for Taggart if they choose alternative #1?        

2. What is the effective annual rate for Taggart if they choose alternative #2?         

3. What is the effective annual rate for Taggart if they choose alternative #3?          

Which alternative should Taggart choose? Explain why

Answer 1

Based on the given data, pls find below workings on the options:

Fund Requirement	1,00,000
Alternative 1- Cash Discount			Alternative 2- Loan			Alternative 3- Loan
Cash Discount Terms	2/5, Net 35		Loan Amount	1,00,000		Loan Amount	1,00,000
			Reqd Compensating Balance	10%
Left out Period
(35-5)	30		APR	9%		APR	12%
			Tenure	30 days		Tenure	30 days
Total No. of Days	30		Interest Cost	740		Interest Cost	986
No.of Times	1.00		Loan Origination Fee	200		Loan Origination Fee	1,000
Discount Cost	2,000		Total Finance Cost	940		Total Finance Cost	1,986
Effective Rate	2.00%		Effective Rate	1.04%		Effective Rate	1.99%
Alternative 1	2.00%
Alternative 2	1.04%
Alternative 3	1.99%

Based on this, it is appropriate to go for Alternative 2;