Suppose that Zimbabwe has a choice of two possible $100 million, five-year Eurodollar loans. The first loan is offered at LIBOR + 1% with a 2.5% syndication fee, whereas the second loan is priced at...

Suppose that Zimbabwe has a choice of two possible $100 million, five-year Eurodollar loans. The first loan is offered at LIBOR + 1% with a 2.5% syndication fee, whereas the second loan is priced at LIBOR + 1.5% and a 0.75% syndication fee. Assuming that Zimbabwe has a 9% cost of capital, which loan is preferable?
Hint: View this as a capital budgeting problem.

Answer.The dollar cash flows associated with these two spread-syndicate fee combinations are as follows:

Loan 1 (2.5% fee, 1% spread)

Loan 2 ().75% fee, 1.5% spread)

Fee

$2,500,000

$750,000

Interest spread

(years 1-5)

$1,000,000

$1,500,000

Using a 9% discount rate, we can compare the present values of these two combinations:

Based on these comparisons, we can see that at a 9% discount rate, the first loan fee-spread combination is the least expensive one.