Busch Corporation has an existing loan in the amount of $6 millionwith an annual interest rate of 6.0%. The company provides an internal companyprepared financial statement to the bank under the loan agreement. Two competingbanks have offered to replace Busch Corporation’s existing loan agreement with a newone. United National Bank has offered to loan Busch $6 million at a rate of 5.0% butrequires Busch to provide financial statements that have been reviewed by a CPA firm.First City Bank has offered to loan Busch $6 million at a rate of 4.0% but requires Busch toprovide financial statements that have been audited by a CPA firm. Busch Corporation’scontroller approached a CPA firm and was given an estimated cost of $35,000 to performa review and $60,000 to perform an audit.a. Explain why the interest rate for the loan that requires a review report is lower thanthat for the loan that did not require a review. Explain why the interest rate for the loanthat requires an audit report is lower than the interest rate for the other two loans.b. Calculate Busch Corporation’s annual costs under each loan agreement, includinginterest and costs for the CPA firm’s services. Indicate whether Busch should keep itsexisting loan, accept the offer from United National Bank, or accept the offer fromFirst City Bank.c. Assume that United National Bank has offered the loan at a rate of 4.5% with areview, and the cost of the audit has increased to $80,000 due to new auditingstandards requirements. Indicate whether Busch should keep its existing loan, acceptthe offer from United National Bank, or accept the offer from First City Bank.
Busch Corporation has an existing loan in the amount of $6 million
with an annual interest rate of 6.0%. The company provides an internal companyprepared financial statement to the bank under the loan agreement. Two competing
banks have offered to replace Busch Corporation’s existing loan agreement with a new
one. United National Bank has offered to loan Busch $6 million at a rate of 5.0% but
requires Busch to provide financial statements that have been reviewed by a CPA firm.
First City Bank has offered to loan Busch $6 million at a rate of 4.0% but requires Busch to
provide financial statements that have been audited by a CPA firm. Busch Corporation’s
controller approached a CPA firm and was given an estimated cost of $35,000 to perform
a review and $60,000 to perform an audit.
a. Explain why the interest rate for the loan that requires a review report is lower than
that for the loan that did not require a review. Explain why the interest rate for the loan
that requires an audit report is lower than the interest rate for the other two loans.
b. Calculate Busch Corporation’s annual costs under each loan agreement, including
interest and costs for the CPA firm’s services. Indicate whether Busch should keep its
existing loan, accept the offer from United National Bank, or accept the offer from
First City Bank.
c. Assume that United National Bank has offered the loan at a rate of 4.5% with a
review, and the cost of the audit has increased to $80,000 due to new auditing
standards requirements. Indicate whether Busch should keep its existing loan, accept
the offer from United National Bank, or accept the offer from First City Bank.
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