The Hand-to-Mouth Company needs $20,000 loan for the next 60 days. It is trying to decide which of the three alternatives to use:
Alternative A: Forgo the discount on its trade credit agreement that offers terms of 3/10, net 60.
Alternative B: Borrow the money from Bank A, which has offered to lend the firm $20,000 for 60 days at an APR of 14%. The bank will require a (no-interest) compensating balance of 7% of the face value of the loan and will charge a $100 loan origination fee, which means Hand-to Mouth must borrow more than $20,000.
Alternative C: Borrow the money from Bank B, which has offered to lend the form $20,000 for 60 days at an APR of 14%. The loan has a 2% origination fee.
Which alternative is the cheapest source of financing for Hand-to-Mouth?
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