This increased gms cost of issuing commercial paper

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Unformatted text preview: ber, led Standard & Poor’s to downgrade senior unsecured debt and shortterm debt for both GM and its GMAC financing arm. This increased GM’s cost of issuing commercial paper for its shortterm financing requirements and also pushed up its longer-term financing costs at a time when its overall financing needs were on the rise. Sources: Adapted from Sholnn Freeman and Gregory White, “GM to Extend 0% Financing Deal to Jan. 2,” Wall Street Journal (November 13, 2001), p. A2; Micheline Maynard, “Auto Sales Dip Slightly from 2000 Record,” San Diego Union-Tribune (January 4, 2002), pp. C1, C3; Jonathan Stempel, “S&P Cuts Ford, General Motors Ratings,” Reuters Business Report (October 15, 2001); and Gregory White, “GM’s 0% Finance Plan Is Good for Economy, Risky for the Company,” Wall Street Journal (October 30, 2001), pp. A1, A8. Interest on Commercial Paper Commercial paper is sold at a discount from its par, or face, value. The interest paid by the issuer of commercial paper is determined by the size of the discount and the length of time to maturity. The actual interest earned by the purchaser is determined by certain calculations, illustrated by the following example. EXAMPLE Bertram Corporation, a large shipbuilder, has just issued $1 million worth of commercial paper that has a 90-day maturity and sells for $980,000. At the end of 90 days, the purchaser of this paper will receive $1 million for its $980,000 investment. The interest paid on the financing is therefore $20,000 on a principal of $980,000. The effective 90-day rate on the paper is 2.04% ($20,000/$980,000). Assuming that the paper is rolled over each 90 days throughout the year, the effective annual rate for Bertram’s commercial paper, found by using Equation 4.23, is 8.41% [(1 0.0204)4 1]. An interesting characteristic of commercial paper is that its interest cost is normally 2 to 4 percent below the prime rate. In other words, firms are able to 648 PART 5 Short-Term Financial Decisions Hint Commercial paper is di...
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