XYZ Company Needs Tk. 50,00,000 To Meet Its Day-to-day Capital Requirement And Considering The Following Three Alternative Sources

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XYZ company needs Tk. 50,00,000 to meet its day-to-day capital requirement and considering the following three alternative sources:
i. The company buys a Tk. 70,00,000 of raw materials under 2/20 net 70 terms.

ii. A bank will lend Tk. 70,00,000 at 12%, with 15% compensating balance requirement. Interest to be paid in advance.

iii. Issue commercial paper of Tk. 70,00,000 for six month period and the net sales value is Tk. 66,50,000.

You are required to choose the cheapest alternative. Which is that alternative?

To choose the cheapest alternative for XYZ company, we calculate the effective annual cost of financing for each of the three options.

Option i: Trade Credit (Forgo Cash Discount)

Credit Terms:
Discount Period:
Net Credit Period:
Days Foregone (Borrowing Period):

Option ii: Bank Loan (Discount Basis with Compensating Balance)

Stated Interest Rate:
Compensating Balance ():
Loan Amount: Tk. 70,00,000
Interest Paid in Advance (Discount Basis):
Compensating Balance Amount:
Usable Funds:

Option iii: Commercial Paper

Face Value: Tk. 70,00,000
Net Sales Value (Proceeds): Tk. 66,50,000
Dollar Discount:
Maturity Period: 6 months (180 days)

Comparison Summary Table

Option	Source of Finance	Effective Annual Cost
Option i	Trade Credit	14.69%
Option ii	Bank Loan	16.44%
Option iii	Commercial Paper	10.53%

Final Decision & Answer:

The cheapest alternative is Option iii: Commercial Paper.

Reason:

Commercial Paper has the lowest effective annual cost at 10.53%, compared to 14.69% for Trade Credit and 16.44% for the Bank Loan. Additionally, its net sales proceeds of Tk. 66,50,000 fully meet the company’s working capital requirement of Tk. 50,00,000.

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