7. Xavier and Zulu. Xavier Manufacturing and Zulu Products both seek funding at the lowest possible cost. Xavier would prefer the flexibility of floating rate borrowing, while Zulu wants the security of fixed rate borrowing. Xavier is the more creditwor thy company. They face the following rate structure. Xavier, with the better credit rating, has lower bor- rowing costs in both types of borrowing:

Xavier wants floating rate debt, so it could bor- row at LIBOR +1%. However it could borrow fixed at 8% and swap for floating rate debt. Zulu wants fixed rate, so it could borrow fixed at 12%. However, it could borrow floating at LIBOR + 2% and swap for fixed rate debt. What should they do?

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Credit rating Fixed rate cost of borrowing Floating rate cost of borrowing Xavier Zulu AAA BBB 8% 12% LIBOR 1% LIBOR +2%