Evaluating Alternative Notes A borrower has two alternatives for a loan: (1) iss
ID: 2583751 • Letter: E
Question
Evaluating Alternative Notes
A borrower has two alternatives for a loan: (1) issue a $390,000, 90-day, 6% note or (2) issue a $390,000, 90-day note that the creditor discounts at 6%. Assume a 360-day year.
a. Calculate the amount of the interest expense for each option.
$ for each alternative.
b. Determine the proceeds received by the borrower in each situation.
c. Alternative 1 is more favorable to the borrower because the borrower receives more cash .
(1) $390,000, 90-day, 6% interest-bearing note $ (2) $390,000, 90-day note discounted at 6% $Explanation / Answer
ans)
a) The interest expense will be the same for both options
390,000 X 6% X 90/360 = 5850
b) 1) 390000
2) 390,000 - 5850 = 384150
c) Option (1) is more favorable. Because option (2) deducts the interest up front, the borrower only receives $384150 in cash, but still has to pay interest of $5850. So in reality, the borrower is paying an interest rate of about 6.11% for option (2).
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