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Question: Swishing Shoe Company. Swishing Shoe Company of Durham, North Carolina, has received an order for 50,000 cartons of athletic shoes from Southampton Footware, Ltd., of England, payment to be in British pounds sterling. The shoes will be shipped to Southampton Footware under the terms of a letter of credit issued by a London Bank on behalf of Southampton Footware. The letter of credit specifies that the face value of the shipment, £400,000, will be paid 120 days after the London bank accepts a draft drawn by Southampton Footware in accordance with the terms of the letter of credit. The current discount rate in London on 120-day banker's acceptances is 12% per annum, and Southampton Footware estimates its weighted average cost of capital to be 18% per annum. The commission for selling a banker's acceptance in the discount market is 2.0% of the face amount.
a. Would Swishing Shoe Company gain by holding the acceptance to maturity, as compared to discounting the banker's acceptance at once?
b. Does Swishing Shoe Company incur any other risks in this transaction?
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