Proctor Micro-Computers, Inc. requires $1,200,000 in financing over the next two years. The firm can borrow the funds for two years at 9.5 percent interest per year. Mr. Procter decides to do economic forecasting and determines that if he utilizes short-term financing instead, he will pay 6.55 percent interest in the first year and 10.95 percent interest in the second year. Determine the total two-year interst cost under each plan. Which plan is less costly

Assuming there is no compound interest…

Plan A - 2 year borrowing Interest cost = 1,200,000 X 9.5% X 2 = $228,000
Plan B - 1 year borrowings Interest cost in year 1 = 1,200,000 X 6.55% = $78,600
1 year borrowings Interest cost in year 2 = 1,200,000 X 10.95% = $131,400
131,400 + 78,600 = $210,000
Plan B is less costly

Well, isn't it fascinating how Mr. Procter is making financial decisions based on economic forecasting? I mean, I usually just flip a coin and hope for the best. But let's crunch some numbers, shall we?

Under the first plan of borrowing at a fixed rate of 9.5 percent for two years, Proctor Micro-Computers will have an interest cost of:
$1,200,000 * 9.5% * 2 years = $228,000

Now, for the second plan with short-term financing at 6.55 percent interest in the first year and 10.95 percent interest in the second year, we need to calculate the interest cost for each year separately.
First-year interest cost: $1,200,000 * 6.55% = $78,600
Second-year interest cost: $1,200,000 * 10.95% = $131,400

Total interest cost for the second plan: $78,600 + $131,400 = $210,000

So, after all that calculation, it turns out the second plan is less costly! The total interest cost for the second plan is $210,000, while the first plan would cost $228,000. Looks like Mr. Procter's economic forecasting paid off. He's saving $18,000!

To calculate the total interest cost under each plan, we need to use the formula:

Total Interest Cost = Principal × Interest Rate × Time

1) Long-term Financing:
Principal = $1,200,000
Interest Rate = 9.5% per year
Time = 2 years

Total Interest Cost = $1,200,000 × 9.5% × 2 = $228,000

2) Short-term Financing:
Interest cost for the first year:
Principal = $1,200,000
Interest Rate = 6.55% per year
Time = 1 year

Interest Cost in Year 1 = $1,200,000 × 6.55% × 1 = $78,360

Interest cost for the second year:
Principal = $1,200,000
Interest Rate = 10.95% per year
Time = 1 year

Interest Cost in Year 2 = $1,200,000 × 10.95% × 1 = $131,400

Total Interest Cost = Interest Cost in Year 1 + Interest Cost in Year 2
= $78,360 + $131,400
= $209,760

Comparing the two plans:
- Long-term financing has a total interest cost of $228,000.
- Short-term financing has a total interest cost of $209,760.

Therefore, the short-term financing plan is less costly in terms of total interest cost.

To determine the total two-year interest cost under each plan, we can calculate the interest cost for each year separately and then sum up the costs.

Let's start with the first plan, where Proctor Micro-Computers, Inc. borrows the funds for two years at 9.5 percent interest per year.

Interest cost for the first year:
$1,200,000 * 9.5% = $114,000

Interest cost for the second year:
$1,200,000 * 9.5% = $114,000

Total interest cost under the first plan:
$114,000 + $114,000 = $228,000

Now let's calculate the interest cost for the second plan, where short-term financing is utilized. In the first year, the interest rate is 6.55 percent, and in the second year, it is 10.95 percent.

Interest cost for the first year:
$1,200,000 * 6.55% = $78,600

Interest cost for the second year:
$1,200,000 * 10.95% = $131,400

Total interest cost under the second plan:
$78,600 + $131,400 = $210,000

Comparing the total interest costs under both plans, we find that the first plan, with a total interest cost of $228,000, is more costly than the second plan, which has a total interest cost of $210,000.

Therefore, the second plan, utilizing short-term financing, is less costly.