Question

Your company is experiencing extreme short term financial needs due to the Covid-19 lockdown. You need £4,290,000 to cover rent, utilities and salary of key employees that have been retained during the 4 months you expect to be affected by the lockdown. After making some phone calls, you’ve been able to get the following offers as sources of funding: 

Bank X is offering £4,290,000 for four months at a stated annual rate of 1.85%, using inventory stored in a field warehouse as collateral. The warehouse charges a £20,000 fee, payable at the end of the four months. 

Bank Y can facilitate borrowing up to £1,000,000 for four months at an APR of 3.2%. 

Bank Z offers £4,500,000 for four months at an APR of 1.85. The bank will require to maintain a (no-interest) compensating balance of 10% of the face-value of the loan and will charge a 0.05% loan origination fee

What would be the best financial strategy that would tide you over the following 4 months? Explain your proposal and show all your calculations

Answer 1

Financing with Bank X

Interest amount =4,290,000 * 1.85%*4/12 =  26455

Warehousing charges = 20000

So, Total Cost per pound borrowed = 46455/4290000 = 0.010829

Financing with Bank Y

Interest amount =1,000,000 * 3.2%*4/12 =  10666.67

So, Total Cost per pound borrowed = 10666.67/4290000 = 0.010667

Financing with Bank Z

Interest amount =4,500,000 * 1.85%*4/12 =  27750

Because of Compensating balance, amount which can be used = 4500000 - 450000 = 4050000

Loan origination fee = 0.05%*4500000 = 2250

Let us assume that the loan origination fee is paid from the Loan amount available (

So, Total Cost per pound borrowed/used = 27750/(4050000-2250) = 0.006856

As the cost of borrowing is the least in Bank Z, one should try to finance the maximum possible amount from Bank Z followed by Bank Y

From Bank Z , one can get (4050000 - 2250) = 4047750 pounds to use

and from Bank Y the remaining amount of (4290000-4047750) = 242250 pounds can be financed

Total cost = 27750+ 242250*0.010667 = 30334.08 pounds