Question

The Brandt Company has been approached by two different commercial paper dealers offering to sell an issue of commercial paper for the company. Dealer A offered to market an $8 million issue maturing in 90 days at an interest cost of 6.5 percent per annum (deducted in advance). The fee to Dealer A would be $15,000. Dealer B has offered to sell a $8 million issue maturing in 150 days at an interest rate of 7.00 percent per annum (deducted in advance). The fee to Dealer B would be $2,500. Assuming that Brandt wishes to minimize the annual financing cost of issuing commercial paper, which dealer should it choose? Assume that there are 365 days per year.

Round your answers to two decimal places.

AFC (Dealer A):    %

AFC (Dealer B):    %

Which dealer would Brandt choose A or B? Type in A or B.

Answer 1

Dealer A:

Interest cost = Principal * Rate * (Number of days / 365)
= $8,000,000 * 6.5% * (90 / 365)
= $128,219.1781

Usable funds = Principal - interest - placement fee
= $8,000,000 - $128,219.1781 - $15,000
= $7,856,780.822

AFC = (Interest + placement fee) / usable fund * (days in a year / days of the loan)

= (($128,219.1781 + $15,000) / $7,856,780.822) * (365 / 90)

= 7.39%

AFC for dealer A = 7.39%

Dealer B:

Interest = Principal * Rate * (Number of days / 365)
= $8,000,000 * 7% * (150 / 365)
= $230,136.9863

Usable funds = Principal - interest - placement fee
= $8,000,000 - $230,136.9863 - $2,500
= $7,767,363.014

AFC = (Interest + placement fee) / usable fund * (days in a year / days of the loan)
= (($230,136.9863 + $2,500) / $7,767,363.014) * (365 / 150)
= 7.29%

AFC for Dealer B = 7.29%

Dealer B has lowest AFC. Thus, the company should choose Dealer B.