Charles Smith recently was hired as president of Dellvoe Office Equipment Inc., a small manufacturer of metal office equipment. As his assistant, you have been asked to review the company’s short-term financing policies and to prepare a report for Smith and the board of directors. To help you get started, Smith has prepared some questions that, when answered, will give him a better idea of the company’s short-term financing policies. In discussing a possible loan with the firm’s banker, Smith found that the bank is willing to lend Dellvoe up to $800,000 for one year at a 9% simple, or quoted, rate. However, he forgot to ask what the specific terms would be.
A. Assume the firm will borrow $800,000. What would be the effective interest rate if the loan were based on simple interest?
B. If the loan had been an 8% simple interest loan for six months rather than for a year, would that have affected the EAR?
C. What would be the EAR if the loan were a discount interest loan?
D. What would be the face amount of a loan large enough to net the firm $800,000 of usable funds?