Mendez Metal Specialties, Inc., has a seasonal pattern to its business. It borrows under a line of

Question:

Mendez Metal Specialties, Inc., has a seasonal pattern to its business. It borrows under a from Central Bank at 1 percent over prime. Its total asset requirements now (at year end) and estimated requirements for the coming year are (in millions):

Assume that these requirements are level throughout the quarter. At present the company has $4.5 million in equity capital plus long-term debt plus the permanent component of current liabilities, and this amount will remain constant throughout the year.
The prime rate currently is 11 percent, and the company expects no change in this rate for the next year. Mendez Metal Specialties is also considering issuing intermediate-term debt at an interest rate of 13.5 percent. In this regard, three alternative amounts are under consideration: zero, $500,000, and $1 million. All additional funds requirements will be borrowed under the company's bank line of credit.
a. Determine the total dollar borrowing costs for short- and intermediate-term debt under each of the three alternatives for the coming year. (Assume that there are no changes in current liabilities other than borrowings.) Which alternative is lowest in cost?
b. Is there a consideration other than expected cost that deserves our attention?

Line of Credit
A line of credit (LOC) is a preset borrowing limit that can be used at any time. The borrower can take money out as needed until the limit is reached, and as money is repaid, it can be borrowed again in the case of an open line of credit. A LOC is...