Question

The Olivera Corp., a manufacturer of olive oil products, needs to acquire Lit 100 million in funds today to expand a pimento‑stuffing facility. Banca di Roma has offered them a choice of an 11 percent loan payable at maturity or a 10 percent loan on a discount basis. Which loan should Olivera choose?

Answer 1

EAR(Loan on a discount basis) = Interest / [Face Value - Interest]

= [$100 million x 10%] / [$100 million - ($100 million x 10%)] = $10 million / $90 million = 11.11%

Hence, the 11% loan is less expensive.