case 2 num. 7

7. Axle Chemical Corporations treasurer has forecasted a $1 million cash deficit for the next quarter. However, there is only a 50% chance this deficit will actually occur. The treasurer estimates that there is a 20% probability the company will have no deficit at all and a 30% probability that it will actually need $2 million in short-term financing. The company can either take out a 90-day unsecured loan for $2 million at 1% per month or establish a line of credit, costing 1% per month on the amount borrowed plus a commitment fee of $20,000.

If excess cash can be reinvested at 9%, which source of financing gives the lower expected cost?