1) The Stoney River Pennant Company uses commercial paper to satisfy part of its

Question

1) The Stoney River Pennant Company uses commercial paper to satisfy part of its short-term financing requirements. Next week, it intends to sell $50 million in 180-day maturity paper on which it expects to have to pay discounted interest at an annual rate of 19 percent per annum. In addition, Stoney River expects to incur a cost of approximately $100,000 in dealer placement fees and other expenses of issuing the paper. What is the effective annual cost of credit to Stoney River (round to the nearest .1 percent)?
a. 14.0%
b. 19.0%
c. 21.5%
d.18.65%

Explanation / Answer

Calculating the Effective annual cost : The formula for calculating the effective annual cost is                                EAC = (1 + A / P) ^p - 1 Where A = Nominal interest rate            P = Number of compounding periods (180-day is semi-annual compounding in a year)                               EAC = ( 1 + 0.19 / 2 )^2 - 1                                        = (1 + 0.095)^2 - 1                                        = 1.1990 - 1                                        = 19.9025% Therefore, the correct option is b) 19.0%

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