Noting that there has been an increasing interest in organic foodstuffs with increasing affluence, Mr Tommy Tan is considering starting an organic food retail business in Singapore. He targets to have 8 retail outlets island-wide by the end of 2021. To maintain its target capital structure, the firm estimates that it will need to borrow $10 million to finance this growth. As the firm is tight on cash, it prefers to repay the loan in full only at the end of 10 years and only wants to service the interest on an annual basis.
The firm has approached several banks in Singapore and 2 banks have signalled interest to be its main financier. JuneBank proposes an annual interest rate of 6.9% and the underwriting spread is 2%. BHR Bank offers the loan at an annual interest rate of 6.5% and the underwriting spread is 2.9%
(a) What is the effective cost of borrowing from JuneBank?
(b) What is the effective cost of borrowing from BHR Bank?
(c) Using the estimations in (a) and (b), determine the bank that the firm should borrow from.