Assume that financing for the cash deficit will be obtained

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Reference no: EM131852858

Universal Autoparts’ treasurer has forecasted a €1.5 million cash deficit for the next quarter. However, there is only a 50 percent chance that this deficit will actually occur. The treasurer estimates that there is a 20 percent probability the company will have no deficit at all, and a 30 percent probability that the deficit will be €3 million. The company can either take out a 90-day unsecured loan with an interest rate of 0.7 percent per month on the amount borrowed or establish a line of credit costing 0.8 percent per month on the amount borrowed. The line of credit has a commitment fee of €20,000 that has to be paid immediately after it has been established. Excess cash can be reinvested at 2.5% return per annum. Assume that financing for the cash deficit will be obtained at the beginning of the quarter before the deficit starts to be realized and that the deficit will prevail until the end of the quarter.

a) Which source of financing is cheaper if the deficit has to be fully covered?

b) How does the expected cost of the unsecured loan change if there is an additional requirement that an amount equal to 20 percent of the outstanding loan must be borrowed and kept in a zero-interest account in the bank until the loan is paid off?

Reference no: EM131852858

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