Chapter 16, Problem 16.10P

Unsecured sources of short-term loans John Savage has obtained a short-term loan from First Carolina Bank. The loan matures in 180 days and is in the amount of $45,000. John needs the money to cover start-up costs in a new business. He hopes to have sufficient backing from other investors in 6 months. First Carolina Bank offers John two financing options for the $45,000 loan: a fixed-rate loan at 2.5% above prime rate or a variable-rate loan at 1.5% above prime.

Currently, the prime rate of interest is 6.5%, and the consensus interest rate forecast of a group of economists is as follows: Sixty days from today the prime rate will rise by 0.5%; 90 days from today the prime rate will rise another 1%; 180 days from today the prime rate will drop by 0.5%.

Using the forecast prime rate changes, answer the following questions.

1. a. Calculate the total interest cost over 180 days for a fixed-rate loan.
2. b. Calculate the total interest cost over 180 days for a variable-rate loan.
3. c. Which is the lower-interest-cost loan for the next 180 days?