The UFSU Corporation intends to borrow $450,000 to support its short-term financing requirements during the next year. The company is evaluating its financing options at the bank where it maintains its checking account. UFSU’s checking account balance, which averages $50,000, can be used to help satisfy any compensating balance requirements the bank might impose. The financing alternatives offered by the bank include the following:,
Alternative 1: A discount interest loan with a simple interest of 9.5 percent and no compensating balance requirement.,
Alternative 2: A 10 percent simple interest loan that has a 15 percent compensating balance requirement.,
Alternative 3: A $1 million revolving line of credit with simple interest of 9¼ percent paid on the amount borrowed and a ¼ percent commitment fee
a. Compute the effective cost (rate) of each financing alternative assuming UFSU borrows $450,000. Which alternative should UFSU use?,
b. For each alternative, how much would UFSU have to borrow to have $450,000 available for use (to pay the firms bills) ?
c. Using the amounts computed in Part b, recalculate the effective cost of each financing alternative. How do the costs differ from those computed in Part a? Explain.