A large finance company issues $3 million of commercial paper with a 50-day maturity at a discount rate of 5%. The paper is sold through a dealer for a charge of .05% of the face value of the commercial paper. There is also a backup line of credit that has a charge of 0.50% of the face value of the paper. Be sure to adjust annual rates for fees by multiplying by 50/360 (i.e. N/360). What is the effective annual cost of issuing the commercial paper?

Question

Quizplus · Accepted Answer

Effective Annual Cost = [Total Issue Cost / Usable Funds] x [360/50]
 Usable funds = $3,000,000 [1 - (.05) x (50/360)] = $2,979,167
 Interest Cost = Face Value - Usable Funds = $3,000,000 - $2,979,167 = $20,833 
Dealer Cost = .0005 x $3,000,000 x (50/360) = $208.33 
Line of Credit Cost = .005 x $3,000,000 x (50/360) = $2,083.33 
Total Issue Cost = Interest Cost + Dealer Cost + Line of Credit Cost 
= $20,833 + $208.33 + $2,083.33 = $23,124.66 
Effective Annual Cost = [$23,124.66/$2,979,167](365/50) = .0567 or 5.67%

A Large Finance Company Issues $3 Million of Commercial Paper