Question

Please answer alternative 1 only. Thank you.

To finance a major expansion program, Manchester Mining PLC, a major British mining company, needs to raise 100 million in pounds sterling. Due to the availability of extensive tax loss carry forwards, Manchester Mining's tax rate effectively equals zero over the next five years. The firm has to decide which one of the following mutually exclusive financing alternatives to adopt. Note that all of the loan alternatives stipulate annual debt service payments and that all interest rates are quoted EAR, i.e., as effective annual rates. Calculate the all-in cost of financing of each one of the following alternatives and, on the basis of this criterion, decide which is best. The all-in cost of financing is the fully hedged cost of financing measured in terms of the reference currency and calculated inclusive of any loan processing fees that may be imposed. Alternative #1 (10%): The Royal Bank of Scotland has offered Manchester Mining pound sterling financing at an interest rate of 8%, charging a loan-processing fee of 6%. The loan would be fully amortized with equal annual debt service payments over a four-year period.

Answer 1

In Million

Fund required	100
Loan Processing Charge	6%
Net Loan amount	106.383

The Loan would be fully amortized with equal annual debt service in 4 Years i.e. Annual Principal Payment = 106.383/4 = 26.596 million

Rate 10% , Present value of Cost of Project

Year	Annual Payment of Principal	Interest Amount	Net Cash Flow	PV@ 10%	Present Value
1	-26.596	-8.511	-35.106	0.909	-31.915
2	-26.596	-6.383	-32.979	0.826	-27.255
3	-26.596	-4.255	-30.851	0.751	-23.179
4	-26.596	-2.128	-28.723	0.683	-19.618
			Present Value of Cost of Project		-101.967

Interest Expense Schedule

Year	Opening Principal	Interest @ 8%	Principal Repayment	Closing Principal
1	106.383	8.511	-26.596	79.787
2	79.787	6.383	-26.596	53.191
3	53.191	4.255	-26.596	26.596
4	26.596	2.128	-26.596	0.000