Bank A offers the following terms for a $10 million loan: * interest rate: 8 per

Question

Bank A offers the following terms for a $10 million loan:
* interest rate: 8 percent for one year on funds borrowed
* fees: 0.5 percent of the unused balance for the unused term ofthe loan

Bank B offers the following terms for a $10 million loan:
* interest rate: 6.6 percent for one year on funds borrowed
* fees: 2 percent origination fee
a) Which terms are better if the firm intends to borrow the $10million for the entire year?
b) If the firm plans to use the funds for only three months, whichterms are better?

Explanation / Answer

Fund borrowed for Full One Year
Bank B offer : Int on Loan for 1yr = 6.6% on $10M =10*0.66 = $0.66M. Fee is 2% = 2% * $10M = $0.2M. So total cost of Loan is0.66+0.2 = $0.86M So if Funds are borrowed for entire year, Bank A isbetter
Fund borrowed for Three monthsonly b. Bank A offer: Int on Loan for 3m = 8% on $10M for 3m =10*0.08*3/12 = $0.2M. Fee wil be NIL as entier amount of $10M is borrowed for 3mwhich is entire term Total cost of Loan from Bank A = $0.2M
Bank B offer: Int on Loan for 3m = 6.6% on $10M for 3m =10*0.066*3/12 = $0.165M. Fee wil be 2% of Loan amount of $10M = 10*0.02 = $0.2M Total cost of Loan from Bank B = $0.165M + $0.2M =$0.365M Thus Bank A is better for 3 month loan also.

Bank B offer: Int on Loan for 3m = 6.6% on $10M for 3m =10*0.066*3/12 = $0.165M. Fee wil be 2% of Loan amount of $10M = 10*0.02 = $0.2M Total cost of Loan from Bank B = $0.165M + $0.2M =$0.365M Thus Bank A is better for 3 month loan also.

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