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

Question

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)?
14.0%
19.0%
21.5%
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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