Question

​(Cost of commercial paper​) ​Tri-State Enterprises plans to issue commercial paper for the first time in the​ firm's 35-year history. The firm plans to issue ​$500, 000 in 270​-day maturity notes. The paper will carry a 10.50 percent rate with discounted interest and will cost​ Tri-State ​$11, 000 ​(paid in​ advance) to issue. Note​: Assume a​ 30-day month and​ 360-day year.

a. What is the effective cost of credit to​ Tri-State?

b. What other factors should the company consider in analyzing whether to issue the commercial​ paper?  

Answer 1

a.
Calculate effective cost of credit to Tri-state
Interest	10.50%*500000*(270/360)
Interest	$39,375
Effective costs of credit	(39375+11000)/(500000-39375-11000)*(360/270)
Effective costs of credit	50375/449625*(360/270)
Effective costs of credit	14.94%
Thus, effective cost of credit is 14.94%
b.
The other factors to be consider include risk of issuing commercial paper
The risk would be in terms of flexibility for repayment as not a single day delay is allowed under the financing
Commercial paper may not be easily for financing