Firenza Motors of Italy recently took out a $4-$year $5$ million loan on a floating rate basis. It is now worried, however, about rising inter$-$ est costs. Although it had initially believed interest rates in the eurozone would be trending downward when taking out the loan, recent economic indica$-$ tors show growing inflationary pressures. Analysts are predicting that the European Central Bank will slow monetary growth driving interest rates up$.$

Firenza is now considering whether to seek some protection against a rise in euro$-$LIBOR, and is con$-$ sidering a forward rate agreement $($FRA$)$ with an insurance company. According to the agreement, Firenza would pay to the insurance company at the end of each year the difference between its initial interest cost at $(6\mathrm{.}50\%)$ and any fall in interest cost due to a fall in LIBOR. Conversely, the insurance company would pay to Firenza $70\%$ of the differ$-$ ence between Firenza$$s initial interest cost and any increase in interest costs caused by a rise in LIBOR.Purchase of the floating rate agreement will cost $100,000,$ paid at the time of the initial loan.

What are Firenza$$s annual financing costs now if LIBOR rises and if LIBOR falls?

Firenza uses $12\%$ as its weighted average cost of capital. Do you recommend that Firenza purchase the FRA?