The Missouri River Pendant Company uses commercial paper to satisfy part of its short-term financing requirements.Next week,it intends to sell $18 million in 90-day maturity paper on which it expects to have to pay discounted interest at an annual rate of 7 percent per annum.In addition,Stoney River expects to incur a cost of approximately $25,000 in dealer placement fees and other expenses of issuing the paper.What is the effective annual cost of credit to Missouri River?

Question

Quizplus · Accepted Answer

The effective annual cost of credit can be calculated by considering both the interest and the additional costs associated with issuing the commercial paper. The interest for 90 days at 7% per annum on $18 million is calculated as $18 million * 7% * (90/365) = $315,000. Adding the dealer placement fees and other expenses of $25,000, the total cost is $315,000 + $25,000 = $340,000. The effective interest rate for 90 days is $340,000 / $18 million = 1.89%. To annualize this rate, considering the compounding effect over the four 90-day periods in a year, the formula is (1 + effective rate for 90 days)^(365/90) - 1. Plugging in the numbers, (1 + 0.0189)^(365/90) - 1 ≈ 7.7%.

The Missouri River Pendant Company Uses Commercial Paper to Satisfy