Reference no: EM131187874
A bank offers a client a choice between two financing options for a one-year period:
Option1: a term-loan for the full year of $500,000 to be repaid at the end of the year with interest fixed at 12% per year.
Option 2: An overdraft, with a quoted rate of 14% per year, with interest charged quarterly on the average balance.
The firm expects to need finance, on average, $400,000 in the first quarter, $500,000 in quarter 2, $500,000 in quarter 3 and only $200,000 in the final quarter due to the seasonal nature of its business.
Unused funds can be invested at 2% per quarter (compounded quarterly). The bank will however not charge interest on accumulated quarterly interest charges (simple interest only).
Which option would you recommend to the client? Support your answer with detailed computations.
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