Question

A school district is borrowing $40,000,000 over 17 years to fund a building expansion project. The school board can borrow annually for 1 year and then MUST borrow long term (16 years) or, can borrow at a long term fixed rate for the 17 years. The school district is looking at severe budget cuts where they are considering laying off a number of personnel. The choices they are considering are to borrow for one year at 1.75% and then must borrow fixed OR they can borrow for 17 years fixed rate at 4.0%. If they borrow for one year then go fixed, they will save $900,000 in interest that year and save all the jobs. They can borrow annually for to five years then must borrow fixed for the rest of the term. . What do you do and why

Answer 1

Answer:

borrow for one year at 1.75% and then must borrow fixed.

Explanation:

This option appears to be more economically advantageous and would save all jobs. Consider why this is the case from the interest paid in each option:

The Interest rate paid at 1.75%:

• for one year at 1.75% = $700, 000 (1.75%x40,000,000)
• for annually up to five years at 1.75%= $3,500,000 (1.75%x40,000,000x5 years).

The Interest rate paid at 4%:

• borrow fixed for 16 years at 4% = $25,600,000 (4% x 40,000,000 x 16)
• borrow fixed for 12 years (17-5) at 4% = $19,200,000  (4% x 40,000,000 x 1,600,000)

Total:

First option = $26,300,000 plus all jobs saved

Second option = $22,700,000

Therefore, the first option is more economically advantageous.