Laurentide Resort Company would like to issue $25 million face value of 60-day commercial paper at a cost of 0.65%.In addition, the firm must maintain the $25 million credit line at a cost of 0.1% as a standby fee.What is the effective annual cost of this transaction?
A)4.02%
B)4.56%
C)4.65%
D)56.57%

Question

Quizplus · Accepted Answer

To calculate the effective annual cost of the transaction, we need to convert the 60-day commercial paper and the standby fee to annual rates.

60-day commercial paper rate = (0.65% x 365 days)/60 days = 3.94%
Standby fee rate = 0.1%

The total cost of the transaction is the sum of the interest expense for the commercial paper and the standby fee:

Total cost = (0.0394 x $25 million) + (0.001 x $25 million) = $985,000

The effective annual cost can be calculated using the following formula:

Effective annual cost = (Total cost / Proceeds) x (365 / Days outstanding)

Since the commercial paper has a face value of $25 million, the proceeds are also $25 million. The days outstanding are 60. Substituting these values, we get:

Effective annual cost = ($985,000 / $25 million) x (365 / 60) = 4.65%

Therefore, the effective annual cost is 4.65%. The best choice is C.

Laurentide Resort Company Would Like to Issue $25 Million Face