Question

Twenty years ago ABC Inc. took out a $100 million loan with an interest rate of 6 percent compounded quarterly over its 35 year life. With interest rates now so low, ABC is now looking to potentially refinance the loan:

1.The accounting department would like to know how much interest was paid on this loan last year?

2.If new debt with an interest rate of 4.75 percent compounded quarterly can be raised with a 2 percent flotation cost, should they refinance this loan?

Answer 1

1. Quarterly interest = 100m x 6% / 4 = 1.5 million

Annual Interest = 1.5m x 4 = 6 million

2. New quarterly interest = 100m x 4.75%/4 = 1.1875 million

Quarterly savings = 312,500

Present Value of savings can be calculated using PV function on a calculator

N = 35 x 4, I/Y = 4.75%/4, PMT = 312,500, FV = 0

=> Compute PV = $21.28 million

Cost of refinancing = 100m x 2% = 2m

NPV of refinancing = 21.28 - 2 = 19.28 million

As NPV > 0, they should refinance the loan.