The Missouri River Pendant Company uses commercial paper to satisfy part of its
ID: 2729459 • Letter: T
Question
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?
a. 7.7%
b. 7.5%
c. 7.3%
d. 7.1%
Explanation / Answer
Interest paid upfront = $18,000,000 * 7% *90 days/365 days = $310,684.93
Dealer fees and other expenses = $25,000
Net amount received = $18,000,000 - $310,684.93 - $25,000 = $17,664,315.07
Total cost incurred = $310,684.93 + $25,000 = $335,684.93
Effective cost of credit = Total cost incurred/Net amount received = $335,684.93/$17,664,315.07 = 0.019 = 1.9%
This is the rate for 90 days
Annual cost of credit = 0.019 * 365 days/90 days = 0.077 = 7.7%
Hence, Answer is a.7.7%