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Answer (B) is correct . The cost of Option I can be calculated as follows: Fraction Amount Rate of?Year Totals Interest expense for quarter $12,000,000 ¡Á 7.0% ¡Â 4 = $210,000 Less:? int.?earned in July (4,000,000) ¡Á 4.0% ¡Â 12 = (13,333) ? Less:? int.?earned in Sept. (2,000,000) ¡Á 4.0% ¡Â 12 = (6,667) Net cost of Opt.?I $190,000 The cost of Option II can be calculated as follows: Fraction Amount Rate of?Year Totals Interest expense for July $?8,000,000 ¡Á 8.0% ¡Â 12 = $??53,333 Interest expense for August 12,000,000 ¡Á 8.0% ¡Â 12 =
Answer (A) is incorrect because Calculating that the commercial paper is $35,000 less expensive than the line of credit results from (1) ignoring the interest earned on unused funds and (2) assuming that $12,000,000 of the line of credit is used each month.
Answer (C) is incorrect because The line of credit is more expensive.
Answer (D) is incorrect because The line of credit is more expensive.