USING EXCEL IF NEEDED FOR CALCULATIONS

You are working in a Paper Company and the company needs to loan money from a bank to cover for the daily expenses. By analyzing the previous data, you come to the conclusion that the daily expenses are pretty stable at $17,000 per day, and the company works for 305 days a year. A bank has agreed to give you the loan, at an annual interest rate of 9% (i.e. for every dollar that you borrow, you will 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 origination fee 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 the bank (i.e. borrow $300,000 loans at a time), (2) the total cost of your borrowing policy, and (3) the number of loans you should borrow in a year. The company would also like to know, if it takes the bank 15 days to process a loan, what is the level of cash on hand at which you should apply for a new loan?

b. Suppose the bank offers you a discount as follows: On any loan amount greater than $500,000, the bank will lower the origination fee to $1,200 plus 2% of the amount borrowed. What is the new optimal borrowing policy, considering the discount?

NOTES- Eventually you have to cover all daily expenses ($17,000/day x 305 days) using the money borrowed from the bank. The question is not how much to borrow in total, but how much to borrow at a time.

- You will always need $17,000 daily expenses on the day of the expense, so don’t think of all the interest that you’ll need to pay, but instead think of the interest as a holding cost associated with the extra money in your account.

- Write down the yearly total cost, and label each component as either the ordering cost, carrying cost, or the purchasing cost.