USING EXCEL IF NEEDED FOR CALCULATIONS
You are working in a Paper Company and the company needs to loanmoney from a bank to cover for the daily expenses. By analyzing theprevious data, you come to the conclusion that the daily expensesare pretty stable at $17,000 per day, and the company works for 305days a year. A bank has agreed to give you the loan, at an annualinterest rate of 9% (i.e. for every dollar that you borrow, youwill pay 9 cents) which will be collected at the end of the year.Any time you take a loan, the bank charges you a loan originationfee of $1,200 plus 2.25% of the amount borrowed.
a. Use an EOQ model to determine the optimal borrowing policy.This includes (1) the amount of loans you should borrow from thebank (i.e. borrow $300,000 loans at a time), (2) the total cost ofyour borrowing policy, and (3) the number of loans you shouldborrow in a year. The company would also like to know, if it takesthe bank 15 days to process a loan, what is the level of cash onhand at which you should apply for a new loan?
b. Suppose the bank offers you a discount as follows: On anyloan amount greater than $500,000, the bank will lower theorigination fee to $1,200 plus 2% of the amount borrowed. What isthe new optimal borrowing policy, considering the discount?
NOTES- Eventually you have to cover all dailyexpenses ($17,000/day x 305 days) using the money borrowed from thebank. The question is not how much to borrow in total, but how muchto borrow at a time.
- You will always need $17,000 daily expenses on the day of theexpense, so don’t think of all the interest that you’ll need topay, but instead think of the interest as a holding cost associatedwith the extra money in your account.
- Write down the yearly total cost, and label eachcomponent as either the ordering cost, carrying cost, or thepurchasing cost.
