Problem
Hand-to-Mouth (H2M) is currently cash-constrained, and must make a decision about whether to delay paying one of its suppliers, or take out a loan. They owe the supplier $12,000 with terms of 1.8/10 Net 40, so the supplier will give them a 1.8% discount if they pay by today (when the discount period expires). Alternatively, they can pay the full $12,000 in one month when the invoice is due. H2M is considering three options:
Alternative I: Forgo the discount on its trade credit agreement, wait and pay the full $12,000 in one month.
Alternative II: Borrow the money needed to pay its supplier today from Bank A, which has offered a one-month loan at an APR of 11.8%. The bank will require a (no-interest) compensating balance of 5.3% of the face value of the loan and will charge a $95 loan origination fee. Because H2M has no cash, it will need to borrow the funds to cover these additional amounts as well.
Alternative III: Borrow the money needed to pay its supplier today from Bank B, which has offered a one-month loan at an APR of 14.8%. The loan has a 1.3% loan origination fee, which again H2M will need to borrow to cover.
Task
Alternative I: What is the effective annual cost?
Alternative II: What is the effective annual cost?
Alternative III: What is the effective annual cost?