Proctor Micro-Computers, Inc. requires $1,200,000 in financing over the next two years. The firm can borrow the funds for two years at 9.5 percent interest per year. Mr. Procter decides to do economic forecasting and determines that if he utilizes short-term financing instead, he will pay 6.55 percent interest in the first year and 10.95 percent interest in the second year. Determine the total two-year interst cost under each plan. Which plan is less costly

Question

Proctor Micro-Computers, Inc. requires $1,200,000 in financing over the next two years.  The firm can borrow the funds for two years at 9.5 percent interest per year.  Mr. Procter decides to do economic forecasting and determines that if he utilizes short-term financing instead, he will pay 6.55 percent interest in the first year and 10.95 percent interest in the second year.  Determine the total two-year interst cost under each plan.  Which plan is less costly

Anonymous · Answer

Assuming there is no compound interest…
Plan A - 2 year borrowing Interest cost = 1,200,000 X 9.5% X 2 = $228,000
Plan B - 1 year borrowings Interest cost in year 1 = 1,200,000 X 6.55% = $78,600
1 year borrowings Interest cost in year 2 = 1,200,000 X 10.95% = $131,400
131,400 + 78,600 = $210,000
Plan B is less costly