Boatler Used Cadillac Co. requires $880,000 in financing over the next two years

Question

Boatler Used Cadillac Co. requires $880,000 in financing over the next two years. The firm can borrow the funds for two years at 10 percent interest per year. Mr. Boatler decides to do forecasting and predicts that if he utilizes short-term financing instead, he will pay 6.75 percent interest in the first year and 6.75 percent interest in the second year. (a) Determine the total two-year interest cost under each plan. (Omit the "$" sign in your response.) Interest cost Fixed cost financing $ Variable short-term financing $ (b) Which plan is less costly? Short-term plan Fixed cost plan

Explanation / Answer

a) As per long term borrowing, interest cost will be= 880000*10%*2=$176000 for 2 yrs interest cost will be $176000 As per short term borrowing, interest cost will be=880000*6.75%*1=59400 interest cost in year 2= 880000x6.57%x1= 57816 for 2 yrs interest cost will be=59400+ 57816= $117216 b) therefore short term cost plan is less costly. (are you sure the question above is correct?? please check the numbers once again. you have written :he will pay 6.75 percent interest in the first year and 6.75 percent interest in the second year, I dont think it will be 6.75% for both the years, please cross check the question once again. I have assumed that the interest rate for year one is 6.75% and year 2 is 6.57%( i am just guessing) please check the numbers and see if there is any mistake in the question itself..

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