When you arrived at work on Friday morning, you found the following memo on your desk addressed to you: From: Jason Katz, Chief Financial Officer RE: Project Evaluation As you are aware, we are in the process of imposing a greater financial discipline. From now on, only those projects will be funded that generate sufficient cash-flows to pay the financing cost every year. The project that you have analysed will be funded entirely through a bank loan which will be paid-off in 10 equal annual instalments. Your project must be able to generate sufficient cash-flows to pay these annual instalments, otherwise, it will not be funded. To understand this requirement better, I am providing everyone with the following example: Suppose a project with a 3 life of 3 years generates cash-flows of 200 million, 150 million, and 80 million in years 1, 2, and 3 respectively. The project is financed through a loan that requires a repayment of 100 million every year for the next 3 years. This project will not be funded because it generates only 80 million in year 3, which is not sufficient to meet the instalment of 100 million that year. I would like you to take another look at your proposed project and get back to me by Monday morning with the answer to the following question: Assuming that your project is funded entirely through a bank loan that must be paid-off in 10 equal annual instalments, what is the maximum interest rate on the loan which lets us meet our financial discipline requirement? I would also like you to provide me with your feedback regarding this new requirement Do the following:

a) Answer the question raised in the memo.

b) Provide your feedback on the new requirement (what are its pros and cons?)