Question
Q7. Polaris is taking out a $5,000,000 two-year loan at a variable rate of LIBOR plus 1.00%. The LIBOR rate will be reset each year
Q7. Polaris is taking out a $5,000,000 two-year loan at a variable rate of LIBOR plus 1.00%. The LIBOR rate will be reset each year at an agreed upon date. The current LIBOR rate is 4.00% per year. The loan has an upfront fee of 2.00%. Loan Interest Rates Year 0 Year 1 Year 2 LIBOR (Floating) 4.00% 4.00% 4.00% Spread (Fixed) 1.00% 1.00% 1.00% Total Interest Payable 5.00% 5.00% 5.00% Interest Cash Flows on Loan LIBOR (Floating) ($200,000) ($200,000) Spread (Fixed) ($50,000) ($50,000) Total Interest ($250,000) ($250,000) Loan Proceeds (Repayment) $4,900,000 ($5,000,000) Total Loan Cash Flows $4,900,000 ($250,000) ($5,250,000) If the LIBOR rate jumps to 5.00% after the first year what will be the AIC for Polaris for the entire loan? a. 5.25% b. 5.50% c. 6.09% d. 6.58% Q8. Ford and BMW are both in the market to borrow $50,000,000. Ford wishes to borrow at a fixed rate but unfortunately their credit rating has been downgraded and they find the best rate for fixed-term bonds is 8%. Ford's management thinks that a fixed rate of 8% is too high and has contacted their primary lender, Bank of America, to inquire about possible alternatives. At the same time BMW is looking to upgrade facilities in the United States and is also looking for $50,000,000 in capital. BMW is in a much stronger financial position than Ford and can borrow at a lower fixed rate of 6.00%. However, BMW is looking to borrow at a lower variable rate to complement their fixed rate debt financing. Bank of America investigates short-term borrowing rates for each of the manufacturers and finds that BMW can borrow at the prime rate of 4.5% while Ford can borrow at prime plus 1%. The bank suggests that a swap agreement can be constructed that benefits Ford, BMW, and the bank. The advantage of a swap agreement for Ford, BMW, and Bank of America is that the risk of repayment is eliminated for all parties, thus resulting in lower costs of financing for both manufacturing firms and a healthy profit for the financial firm. a. true b. false
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