Question

CB Solutions. Heather O'Reilly, the treasurer of CB Solutions, believes interest rates are going to rise, so she wants to swap her future floating rate interest payments for fixed rates. Presently, she is paying LIBOR plus 2.00% per annum on $5,000,000 of debt for the next two years, with payments due semiannually. LIBOR is currently 4.02% per annum. Heather has just made an interest payment today, so the next payment is due six months from today. Heather finds that she can swap her current floating rate payments for fixed payments of 7.002% per annum. (CB Solutions' weighted average cost of capital is 12%, which Heather calculates to be 6% per six-month period, compounded semiannually). a. If LIBOR rises at the rate of 50 basis points per six-month period, starting tomorrow, how much does Heather save or cost her company by making this swap? b. If LIBOR falls at the rate of 25 basis points per six-month period, starting tomorrow, how much does Heather save or cost her company by making this swap?

Answer 1

The Values provided in the Question are
Interest rate going to rise	Swap	Floting rate to Fixed rate
Interest rate going to rise	Swap	Floting rate to Fixed rate for 7.002% P.A
Weighted Average Cost of Capital (WACC)	12%	(6% per Six month period, compunded semiannually)
Floting rate of Interest	LIBOR + 2.00% P.A
	6.0200%	PA	3.01	half yearly
Fixed rate of interest	7.0020%	PA	3.501	Half yearly
DEBT	$5000000	( For Next 2 years)
Payment cycle	Semiannually
LIBOR	4.02% P.A	(2.01% for 6 month period)
Next payment	6 Months
		WACC	Rate of interest	Total cost of Capital
Net Cost to company	Floating	300000	150500	450500
	Fixed	300000	175050	475050
Q) If LIBOR raises @ 50 basis points
LIBOR	2.01
Raises	0.5
Total LIBOR	2.51
Floting rate of Interest	3.01	(Half yearly)
LIBOR RAISES by 50 basis points	0.5	(Half yearly)
	3.51
Floting rate of Interest	3.501	(Half yearly)
LIBOR RAISES by 50 basis points	0.5	(Half yearly)
	4.001
		WACC	Rate of interest	Total cost of Capital
Net Cost to company	Floating	300000	175500	475500
	Fixed	300000	200050	500050
				-24550
Company is making loss of Rs 25000(475050 - 500050) If LIBOR raises @ 50 basis points
Q) If LIBOR falls @ 50 basis points
LIBOR	2.01
Falls	0.5
Total LIBOR	1.51
Floting rate of Interest	3.01	(Half yearly)
LIBOR Falls by 50 basis points	0.5	(Half yearly)
	2.51
Floting rate of Interest	3.501	(Half yearly)
LIBOR RAISES by 50 basis points	0.5	(Half yearly)
	3.001
		WACC	Rate of interest	Total cost of Capital
Net Cost to company	Floating	300000	125500	425500
	Fixed	300000	150050	450050
				-24550
Company is making profit of Rs 25000(475050 - 500050) , If LIBOR falls @ 50 basis points