Boles Corporation needs to raise $500,000 for one year to supply capital to a ne
ID: 2707560 • Letter: B
Question
Boles Corporation needs to raise $500,000 for one year to supply capital to a new store. Boles buys from its suppliers on terms of 3/10, net 90, and it currently pays on Day 10 and takes discounts, but it could forgo discounts, pay on Day 90, and get the needed $500,000 in the form of costly trade credit. Alternatively, Boles could borrow from its bank on a 12-percent discount interest basis. What is the EAR on the lower cost of source? (Make sure if applicable to use a 360 day year.)
Explanation / Answer
There are two alternative option for Boles Corp,
Alternative 1: Instead of paying 485,000 ( 3% discount from 500,000) at day 10, Boles paid at Day 90 with full amount of 500,000
Cost of capital for 80 days
= ( 500,000 / 485,000 ) - 1
= 3.09%
EAR
= (1.0309) ^(360/80)
= 14.69%
Alternative 2: Paid 485,000 at day 10. Then borrow from bank with 12% discount interest basis
EAR = 12%
Therefore, alternative 2 has the lower cost of capital. Boles should pay the supplier at day 10 and borrow from bank for any capital needed.