Riley Co. is considering a short-term or long-term financing plan of $4,000,000 assets. It expects the following one-year interest rates over the next three years: 6.5%, 7.75%, and 9%. The long-term interest rate will be 7.5% during those three years. What will be the difference in interest costs over the three years?
A) Long-term interest will be $630,000 more than short-term interest.
B) Long-term interest will be $30,000 less than short-term interest.
C) Long-term interest will be $140,000 less than short-term interest.
D) None of the options are true.

Question

Quizplus · Accepted Answer

Cost of Three Year Fixed Cost Financing
$4,000,000 borrowed @ 7.5% per annum × 3 years = $900,000 interest cost
Cost of Three Year Variable Short-term Financing
1st year $4,000,000 × 6.5% per annum = $260,000 interest cost
2nd year $4,000,000 × 7.75% per annum = 310,000 interest cost
3rd year $4,000,000 × 9% per annum = 360,000 interest cost
$ 930,000 total interest cost
The long-term plan is $30,000 less costly

Riley Co Is Considering a Short-Term or Long-Term Financing Plan of of $4,000,000