Riley Co. is considering a short-term or long-term financing plan for $4,000,000
ID: 2739105 • Letter: R
Question
Riley Co. is considering a short-term or long-term financing plan for $4,000,000 in assets. They expect the following one-year rates over the next three years: 6.5%, 7.75%, and 9%. Their long-term interest rate will be 7.5% for the three years. Assuming the rates follow their expectations, what will be the difference in interest costs over the three years?
None of the options
Long-term interest will be $30,000 less than short-term interest.
Long-term interest will be $140,000 less than short-term interest.
Long-term interest will be $30,000 more than short-term interest.
Explanation / Answer
Short Term Interest:
Interest = Principal x rate of interest x time
year
Principal
Rate of Interest
Interest
1
4,000,000
6.5
$ 260,000
2
4,000,000
7.75
$ 310,000
3
4,000,000
9
$ 360,000
Total
$ 930,000
Long Term Interest:
Interest = Principal x rate of interest x time
=4,000,000 x 7.5% x 3
=$900,000
Long-term interest will be $30,000 less than short-term interest.
Option 2 correct
year
Principal
Rate of Interest
Interest
1
4,000,000
6.5
$ 260,000
2
4,000,000
7.75
$ 310,000
3
4,000,000
9
$ 360,000
Total
$ 930,000
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