1. Commercial paper (beginner). Toro, theWisconsin-based AA-rated manufacturer of snowblowers and lawn mowers, anticipates that because of the seasonal nature of its business it will require an additional US$250 million for working capital during the second quarter (April, May, and June). The funding options are:

■ Bank loan from Wachovia Trust in the form of a one-year line of credit for US$250 million at the annual rate of 6 percent.Wachovia charges a commitment fee of 0.1 percent on the unused portion of the line of credit. ■ Commercial paper issued for 90 days at the annual interest rate of 4.75 percent.

Issuance cost, including the expense of a backup line of credit (credit enhancement), is 10 basis points of the amount issued.

a. Compute the cost of each funding option.

b. How do you explain the difference in funding cost?

c. Would the funding cost faced by Toro be different if it were AAA-rated?

d. Would you recommend that Toro select the cheaper funding option?