Reference no: EM133061460
Questions -
Q1. WS is considering bidding to sell $100,000 of ski equipment to Phang Family Enterprises of Seoul, Korea. Payment would be due in 6 months. Since WS cannot find good credit information on Phang, WS wants to protect its credit risk. It is considering the following solution.
Phang's bank issues a letter of credit on behalf of Phang and agrees to accept WS's draft for $100,000 due in 6 months.
The acceptance fee would cost WS $500, plus reduce Phang's available credit line by $100,000.
The bankers' acceptance note of $100,000 would be sold at a 2% per annum discount in the money market.
What is the annualized percentage all-in cost to WS of this bankers' acceptance financing?
Q2. Umaru Oil of Nigeria has purchased oil drilling equipment from Gunslinger Drilling of Houston Texas.
Umaru must pay for the equipment over the next 5 years at a rate of $200,000 per year due on March 1st each year.
Bank of Zurich, a Swiss forfeiter, has agreed to buy the 5 notes of $200,000 each at a discount.
The discount rate would be approximately 8% per annum based on the expected 3-year LIBOR rate plus 200 basis points, paid by Umaru Oil. Bank of Zurich also would charge Umaru Oil an additional fee of 2% per annum from the date of its commitment to finance until receipt of the actual discounted notes issued in accordance with the financing contract. The $200,000 promissory notes will come due on March 1st in successive years.
The promissory notes issued by Umaru Oil will be endorsed by their bank, Lagos City Bank, for a 1% fee and delivered to Gunslinger Drilling. At this point Gunslinger Drilling will endorse the notes without recourse and discount them to a forfeiter, bank of Zurich, receiving the full $200,000 principal amount.
Bank of Zurich will sell the notes by re-discounting them to investors in the international money market without recourse.
At maturity the investors holding the notes will present them for collection at Lagos City Bank.
If Lagos City Bank defaults on payment, the investors will collect the notes from Bank of Zurich.
a. What is the annualized percentage all-in-cost to Umaru Oil of financing the first $200,000 note due in March 1, 2011?
b. What might motivate Umaru Oil to use this relatively expensive alternative for financing?