Question

biochemical corporation requires $610,000 in financing over the next three years. the firm can borrow the funds for three years at 10.90 percent interest per year. the ceo decides to do a forecast and predicts that if she utilizes short-term financing instead, she will pay 7.75 percent interest in the first year, 12.50 percent interest in the second year, and 8.75 percent interest in the third year. assume interest is paid in full at the end of each year. determine the total interest cost under each plan.

Answer 1

The total interest cost for the Biochemical Corporation over three years is $199,470 with long-term financing at 10.90% interest and $176,900 with short-term financing at varying rates of 7.75%, 12.50%, and 8.75% per year. Short-term financing saves the company $22,570.

Step-by-step explanation:

To determine the total interest cost under each financing plan for the Biochemical Corporation, we need to calculate the amount of interest paid annually and then sum it up for all three years. Under the long-term financing option with a 10.90 percent annual interest rate, the interest cost can be calculated as follows:

• Year 1: $610,000 × 0.1090 = $66,490
• Year 2: $610,000 × 0.1090 = $66,490
• Year 3: $610,000 × 0.1090 = $66,490

The total interest cost for long-term financing over three years is:

$66,490 × 3 = $199,470

Under the short-term financing option with varying annual interest rates, the interest cost is calculated as follows:

• Year 1: $610,000 × 0.0775 = $47,275
• Year 2: $610,000 × 0.1250 = $76,250
• Year 3: $610,000 × 0.0875 = $53,375

The total interest cost for short-term financing over three years is:

$47,275 + $76,250 + $53,375 = $176,900

Comparing the total interest costs, the short-term financing option saves the company:

$199,470 - $176,900 = $22,570