Unsecured sources of short term loans John Savage has obtained a short term loan from First Carolina Bank. The loan matures in 180 days and is in the amount of $45,000. John needs the money to cover start up costs in a new business. He hopes to have sufficient backing from other investors by the end of the next 6 months. First Carolina Bank offers John two financing options for the $45,000 loan: a fixed rate loan at 2.5% above prime rate, or a variable rate loan at 1.5% above prime.
Currently, the prime rate of interest is 6.5%, and the consensus forecasts of a group of mortgage economists for changes in the prime rate over the next 180 days are as follows: Sixty days from today the prime rate will rise by 0.5%; 90 days from today the prime rate will rise another 1%; 180 days from today the prime rate will drop by 0.5%.
Using the forecast prime rate changes, answer the following questions.
a. Calculate the total interest cost over 180 days for a fixed rate loan.
b. Calculate the total interest cost over 180 days for a variable rate loan.
c. Which is the lower interest cost loan for the next 180 days?