You have been assigned to estimate the interest rates that your company may have

Question

You have been assigned to estimate the interest rates that your company may have to pay when borrowing money in the near future. The following information is available.

kPR = 2%

MR = .1% for a 1 year loan increasing by .1% for each additional year

LR = .05% for a 1 year loan increasing by .05% for each additional year

DR = 0 for a 1 year loan, .2% for a 2 year loan, increasing.1% for each additional year

Expected Inflation Rates

           Year 1 = 7%

           Year 2 = 5%

           Year 3 and thereafter = 3%

a.         Calculate the inflation adjustment (INFL) for a 5-year loan.   

b.         Calculate the appropriate interest rate for a 5-year loan.

I WANT TO SEE YOUR CALCULATIONS!

Explanation / Answer

Inflation Adjustment for a 5 year loan = (7% + 5% + 3% + 3% + 3%)/5 = 21%/5 = 4.2%

Appropriate Interest Rate for a 5 year Loan = kPR + INFL + DR + LR + MR

                                = 2 + 4.2 + (0.2 + 3 * 0.1) + 5 * 0.05 + 5 * 0.1      

                               = 2 + 4.2 + 0.5 + 0.25 + 0.5 = 7.45%

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