amount borrowed plus a commitment fee of Rs.20, 000. Both alternatives also required a 20% compensating balance for outstanding loans. If excess cash can be reinvested at 9% which source of financing gives the lower expected cost?

EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN:9781337514835
Author:MOYER
Publisher:MOYER
Chapter17: The Management Of Cash And Marketable Securities
Section: Chapter Questions
Problem 2P
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Axle India Ltd's financial manager has forecast a Rs.1 million cash deficit for the
next quarter. However, there is only a 50% chance this deficit will actually
occur. The treasurer estimates that there is a 20% probability the company will
have no deficit at all and a 30% probability that it will actually need Rs.2 million
in short-term financing. The company can either take out a 90-day unsecured
loan at 1% per month or establish a line of credit, costing 1% per month on the
amount borrowed plus a commitment fee of Rs.20, 000. Both alternatives also
required a 20% compensating balance for outstanding loans. If excess cash can
be reinvested at 9% which source of financing gives the lower expected cost?
Transcribed Image Text:Axle India Ltd's financial manager has forecast a Rs.1 million cash deficit for the next quarter. However, there is only a 50% chance this deficit will actually occur. The treasurer estimates that there is a 20% probability the company will have no deficit at all and a 30% probability that it will actually need Rs.2 million in short-term financing. The company can either take out a 90-day unsecured loan at 1% per month or establish a line of credit, costing 1% per month on the amount borrowed plus a commitment fee of Rs.20, 000. Both alternatives also required a 20% compensating balance for outstanding loans. If excess cash can be reinvested at 9% which source of financing gives the lower expected cost?
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