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
2.42.4/10 Net 40, so the supplier will give them a 2.4% 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 A: Forgo the discount on its trade credit agreement, wait and pay the full $12,000
in one month.
Alternative B: Borrow the money needed to pay its supplier today from Bank A, which has offered a one-month loan at an APR of 11.5%. The bank will require a (no-interest) compensating balance of 4.9% of the face value of the loan and will charge a $90 loan origination fee. Because H2M has no cash, it will need to borrow the funds to cover these additional amounts as well.
Alternative C: Borrow the money needed to pay its supplier today from Bank B, which has offered a one-month loan at an APR of 14.5%. The loan has a 0.8% loan origination fee, which again H2M will need to borrow to cover.