Reference no: EM131419848
Suntime Boats Limited estimates that because of the seasonal nature of its business, it will require an additional $2 million of cash for the month of July. Suntime Boats has the following four options available for raising the needed funds:
(1) Establish a one-year line of credit for $2 million with a commercial bank. The commitment fee will be 1/2 percent per year on the unused portion, and the interest charge on the used funds will be 11 percent per annum. Assume that the funds are needed only in July and that them are 30 days in July and 360 days in the year.
(2) Forgo the cash discount of 2/10, net 40 on $2 million of purchases during July.
(3) Issue $2 million of 30-day commercial paper at a 9 1/2 percent simple annual interest rate. The total transactions fee, including the cost of a backup credit line, on using commercial paper is 1/2 percent of the amount of the issue.
(4) Issue $2 million of 60-day commercial paper at a 9 percent per annum interest rate, plus a transactions fee of 1/2 percent. Because the funds are required for only 30 days, the excess funds ($2 million) can be invested in 9A percent per annum marketable securities for the month of August. The total transactions cost of purchasing and selling the marketable securities is 0.4 percent of the amount of the issue.
a. What is the dollar cost of each financing arrangement?
b. Is the source with the lowest expected cost necessarily the one to select? Why or why not?
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