Hand-to-Mouth
Hand-to-Mouth is currently cash-constrained, and must make a decision about whether to delay paying one of its suppliers, or taking out a loan. They owe the supplier $10,500, but the supplier will give them a 1.6% discount if they pay by today (when the discount period expires). That is, they can either pay $10,332 today, or $10,500 in one month when the net invoice is due. Because Hand-to-Mouth does not have the $10,332 in cash right now, it is considering three options: Alternative A: Forgo the discount on its trade credit agreement, wait and pay the full $10,500 in one month. Alternative B: Borrow the money from Bank A, which has offered to lend the firm $10,332 for one month at an APR (compounded monthly) of 11.7%. The bank will require a (no-interest) compensating balance of 4.8% of the face value of the loan and will charge a $95 loan origination fee, which means Hand-to-Mouth must borrow even more than the$10,332. Alternative C: Borrow the money from Bank B, which has offered to lend the firm $10,332 for one month at an APR 14.5% (compounded monthly). The loan has a 0.8% loan origination fee.
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