5. Unsecured sources of short-term loans Personal Finance Problem- John Savage h

Question

5. Unsecured sources of short-term loansPersonal Finance Problem-John Savage has obtained a short-term loan from First Carolina Bank. The loan matures in 180 days and is in the amount of $41,000 John needs the money to cover start-up costs in a new business. He hopes to have sufficient backing from other investors by the end of the next 6 months. First Carolina Bank offers John two financing options for the $41,000 loan: a fixed-rate loan at 2.4 % above the prime rate, or a variable-rate loan at 1.3 % above prime.Currently, the prime rate of interest is 6.9 %, and the consensus interest rate forecast of a group of economists is as follows: 60 days from today the prime rate will rise by 0.3 %; 90 days from today the prime rate will rise another 1.4 % 180 days from today the prime rate will drop by 0.5 % Using the forecast prime rate changes, answer the following questions. Assume a 365-day year.

a.Calculate the total interest cost over 180 days for a fixed-rate loan.

b.Calculate the total interest cost over 180 days for a variable-rate loan.

c.Which is the lower-interest-cost loan for the next 180 days?

Round all answers to the nearest cent

Explanation / Answer

Answer for question no.a:

Fixed rate loan=2.4%

Prime rate of interest=6.9%.

Therefore, applicable interest rate=6.9%+2.4%

=9.3%.

Interest cover of the loan=$41,000 *9.3%*180/365

=$1,880.38

Answer for question no.b:

Answer for question no.c:

Variable rate loan is resulting into low interest cost.

Hence, variable rate should be preferred.

Number of days Prime rate Applicable rate Interst cost Up to 60 days 6.90% 8.200% 552.6575342 From 61 dyas to 90 days 7.200% 8.500% 286.4383562 From 91 days to 8.600% 9.900% 1000.849315 Total Interest cost 1839.945205

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