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CS Professional · Strategic Management and Corporate Finance · Raising of Funds - Non Fund Based

Kaveri Exports Ltd has a bank guarantee limit sanctioned against a 25% cash margin. A guarantee of Rs 40,00,000 is issued for 2 years at 2% per annum commission, payable yearly in advance. The margin is kept in a deposit earning 5% per annum, whereas the company's borrowing cost is 10%. Ignoring tax, what is the net annual cost of the arrangement to Kaveri, treating commission plus the interest sacrificed on the margin (borrowing cost less deposit rate)?

The net annual cost is Rs 1,30,000. Commission is 2% of Rs 40 lakh, or Rs 80,000, and the Rs 10 lakh margin costs a net 5% (10% borrowing less 5% deposit), or Rs 50,000. The two amounts together give Rs 1,30,000.

  1. ARs 80,000
  2. BRs 1,30,000Correct
  3. CRs 1,60,000
  4. DRs 1,05,000

Explanation

Commission = 2% x 40,00,000 = Rs 80,000. Margin = 25% x 40,00,000 = Rs 10,00,000. Interest sacrificed = (10% - 5%) x 10,00,000 = Rs 50,000. Total = Rs 1,30,000. Rs 80,000 ignores the margin cost; Rs 1,60,000 uses 10% on margin plus commission wrongly after double counting.

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