A bank is in the process of renegotiating an $100 million loan. If liquidated, it expects to receive $96 million.
The new loan will lower interest rates to 6.5% and extend the maturity to seven years. A grace period of three years is offered during which time only interest will be paid.
Principal payments of $25 million are expected at the end of the last four years. An up-front fee of 1% will be collected as part of the renegotiation.
a) If the cost of funds to the bank is 8% after rescheduling, is the bank better of with the new terms? Explain.
b) What should the minimum up-front fee in percent be in for the bank to reschedule the loan?