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Cost of Bank Loans

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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. The financing alternatives offered by the bank include the following:

Alternative 1: A discount interest loan with a simple interest of 9.5 percent

Alternative 2: A bank loan with 10.5 percent interest that is paid at the maturity of the loan (at the end of the year)

Alternative 3: A $1 million revolving line of credit with interest of 9.25 percent paid on the amount borrowed at the end of the year and a 0.25 percent commitment fee paid on the unused balance.

Compute both the APR and the effective cost of each financing alternative assuming that UFSU borrows $450,000. Which alternative should UFSU use?

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Solution Summary

The solution evaluates 3 alternatives for cost of bank loans

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Alternative 1: A discount interest loan with a simple interest of 9.5 percent
When the bank discount calculation method is used, interest is calculated on the amount to be paid back, and the borrower receives the difference between the amount to be paid back and the interest amount. The bank discount method is also referred to as the discount basis.

Amount required= $450,000
Interest rate= 9.50%
Since the loan is ...

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