Question As treasurer of your firm, you wish to establish a credit line facility
ID: 2722125 • Letter: Q
Question
Question As treasurer of your firm, you wish to establish a credit line facility to cover an expected average annual borrowing of $65 million. You hav e asked two banks to submit proposals for a credit line of $80 million. Based on the credit line of $55 million, Bank of the West proposes a nominal rate of 6%, a commitment fee of .25% on the unused portion of the credit line, and a 20% compensating balance on the amount borrowed. Bank of the East offers a rate of 5.75% if the size of the credit line is $95 million. In addition, the commitment fee on the unused portion of the credit line is 20 basis points, and compensating balances of 25% will be required on the amount borrowed. Calculate the effective cost of both proposals, and indicate which proposal should be accepted.
Explanation / Answer
Effective cost for the bank of west is less than bank of east so, we should accept the proposal of bank of west
bank of west Bank of east Nominal rate+0.25=6 nominal rate+25%=5.75% Commitment Fee of .25 Unused portion Commitment Fee of 25% Unused portion Credit facility 55 $ Millions 95 $ Million Amount borrowed 65 $ Millions 65 $ Million unused credit -10 $ Millions 30 $ Million Interest amount borrowed65*6% 3.9 3.7375 (65*5.75% interest on unused credit -10*.25% -0.025 7.5 (30*25%) total cost 3.875 11.2375 Effective cost of credit line 3.875/65 0.059615 0.172884615 in % 5.961538 17.28846154