Your company’s CFO has been in the process of negotiating a $10 million term loan from the company’s banker, AAA. The loan is required for a term of 4 years, with the bank offering quarterly repayments (at the end of each period). Presently, the bank is promoting a “special” APR of 8% p.a., which is claimed to be a good deal because – being at a fixed rate – it avoids exposure to uncertainties in international financial markets (from which the bank sources a large part of its funding).
However, towards the end of the negotiation period with AAA, the company’s CFO was courted by a new bank, ZZZ. After returning from a long lunch with the new bank’s marketing manager, the CFO proudly stated that he had agreed in principle to take the loan from ZZZ, saying: “ZZZ will save us about $1,500 per quarter, not a bad result for a free lunch.” (This is based on ZZZ’s proposal to advance the loan for 4 years with a fixed repayment of $245,000 at the end of each month).
The CEO is suspicious of this “about face” by the CFO, mainly because she believes ZZZ uses aggressive marketing policies. Thus, instead of going back to the CFO (whom, she feels, might not be impartial), the CEO has asked you to write a brief memo explaining the three points (a) to (c) below. (The CEO will use this as an aide memoire at the next board meeting, when she and the directors will make a decision about awarding the loan contract to one or the other of the banks):
a) Why is the CFO claiming that the company will save $1,500 per quarter?
b) Is the CFO’s reasoning fundamentally flawed from the viewpoint of any particular principle of finance?
c) Are there any suitable ways of showing objectively which of ZZZ or AAA is the least expensive loan? (Please provide supporting computations, if possible.)
Assume that, after writing the above memo containing points (a) to (c), the CFO has discovered that AAA will also charge an upfront application fee of $80,000, which the bank says was omitted from the preliminary negotiations “because it has no bearing on the favourable interest rate”. The CFO says that this “sneaky move by AAA” will swing the loan in ZZZ’s favour and so the CEO has asked you to add another section (part d) to the memo, explaining this fee’s effect on the loan comparison.
Just a few hours before the board meeting, the CEO has also found out that ZZZ wants a “transaction fee” of $950 per quarter and so the CEO also wants another section (e) added to the memo, to explain the effect of this fee on the loan comparison, along with a final section (f)., your brief recommendation to the board.
The question belongs to Finance and it discusses about taking term loans from banks and writing a memo about loan procedure from two bank options that have been discussed in the question.
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