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(Cost of commercial paper​) Tri-State Enterprises plans to issue commercial paper for the first time in...

(Cost of commercial paper​) Tri-State Enterprises plans to issue commercial paper for the first time in the​ firm's 35-year history. The firm plans to issue $400,000 in 270​-day maturity notes. The paper will carry a 10.25 percent rate with discounted interest and will cost​ Tri-State $11,000 ​(paid in​ advance) to issue. Note​: Assume a​ 30-day month and​ 360-day year.

a. What is the effective cost of credit to​ Tri-State?

b. What other factors should the company consider in analyzing whether to issue the commercial​ paper?  

Solutions

Expert Solution

a.
Formula to calculate effective cost of credit
Effective cost of credit (Interest expense+Issue costs)/Principal*(1/period of time)
Calculation of total cost of issue
Interest expense $30,750 400000*10.25%*(270/360)
Issue costs $11,000
Total cost of issue $41,750
Effective cost of credit 41750/(400000-41750)*(360/270)
Effective cost of credit (41750/358250)*(360/270)
Effective cost of credit 15.54%
b.
Company will have to consider the fact that if commercial paper are issued then repayment will have to be done on the due date, there would be no extention of due date.
Also commercial paper are allowed to be issued only to borrowers who have higher credit quality, this mean they have no or minimal default risk.
Thus, company should consider the fact whether it will be able to issue the commercial paper or not.

jeff jeffy answered 1 month ago
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