8. Cost of commercial paper Commercial paper is usually sold at a discount. Fan

Question

8. Cost of commercial paper Commercial paper is usually sold at a discount. Fan Corporation has just sold an issue of 89-day commercial paper with a face value of $0.6 million. The firm has received initial proceeds of $589,248. (Note: Assume a 365-day year.)

a.What effective annual rate will the firm pay for financing with commercial paper, assuming that it is rolled over every 89 days throughout the year?

b. If a brokerage fee of $5,634 was paid from the initial proceeds to an investment banker for selling the issue, what effective annual rate will the firm pay, assuming that the paper is rolled over every 89 days throughout the year?

Round both answers two decimal places

Explanation / Answer

a)

89 days rate = 1 - 589248 / 600000 = 1.792%

Periods in a year = 365/89 = 4.101

EAR = (1+ 1.792%)4.101 - 1 = 7.56%

b)

net proceeds = 589248 - 5634 = 583614

89 days rate = 1 - 583614/ 600000 = 2.731%

EAR = (1+ 2.731%)4.101 - 1 = 11.68%

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