Question

​O'Reilly and CB Solutions. Heather​ O'Reilly, the treasurer of CB​ Solutions, believes interest rates are going to​ rise, so she wants to swap her future​ floating-rate interest payments for fixed rates.​ Presently, she is paying LIBOR+2.00​% per annum on $5,200,000 of debt for the next two​ years, with payments due semiannually. LIBOR is currently 4.02​% per annum. Heather has just made an interest payment​ today, so the next payment is due six months from now. Heather finds that she can swap her current​ floating-rate payments for fixed payments of 7.002​% per annum. ​ (CB Solutions' weighted average cost of capital is 12​%, which Heather calculates to be 6​% per​ 6-month period, compounded​ semiannually).

a. If LIBOR rises at the rate of 50 basis points per​ 6-month period, starting​ tomorrow, how much does Heather save or cost her company by making this​ swap?

b. If LIBOR falls at the rate of 25 basis points per​ 6-month period, starting​ tomorrow, how much does Heather save or cost her company by making this​ swap?

Answer 1

a)
Under Floating Payment
Current LIBOR (A) (p.a.)	4.02%
Current payment above LIBOR ( B ) (p.a)	2.00%
Current Floating Rate (A+B) (p.a.)	6.02%
Current Floating Rate (A+B)/2 (six months)	3.01%
If LIBOR increases by 50 Basis point	0.50%
Floating Rate to be paid (six Months) (A+B)/2 +0.50% --->(D)	3.510%
Loan Amount ( C )	5200000.00
Interest Expense after 6 months under floating rate (C *D) ---->( E )	182520.00
Under Fixed Payment
Fixed Rate (p.a) ( F )	7.002%
Fixed Rate (six months) (F/2 ) ---->( G )	3.501%
Loan Amount ( C )	5200000.00
Interest Expense after 6 months under fixed rate (G * C) ---->(H)	182052.00
Extra amount of Interest to be paid after 6 months under fixed rate (H -E)	-468.00
WACC (six months)	6.00%
Present Value of Extra amount of Interest to be paid after 6 months	-441.51
Thus swap savings for the six month period	441.51

b)
Under Floating Payment
Current LIBOR (A) (p.a.)	4.02%
Current payment above LIBOR ( B ) (p.a)	2.00%
Current Floating Rate (A+B) (p.a.)	6.02%
Current Floating Rate (A+B)/2 (six months)	3.01%
If LIBOR falls by 25 Basis point	-0.25%
Floating Rate to be paid (six Months) (A+B)/2 + ( -0.25%) --->(D)	2.760%
Loan Amount ( C )	5200000.00
Interest Expense after 6 months under floating rate (C *D) ---->( E )	143520.00
Under Fixed Payment
Fixed Rate (p.a) ( F )	7.002%
Fixed Rate (six months) (F/2 ) ---->( G )	3.501%
Loan Amount ( C )	5200000.00
Interest Expense after 6 months under fixed rate (G * C) ---->(H)	182052.00
Extra amount of Interest to be paid after 6 months under fixed rate (H -E)	38532.00
WACC (six months)	6.00%
Present Value of Extra amount of Interest to be paid after 6 months	36350.94
Thus swap cost for the six month period	36350.94

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