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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 company-prepared financial statement to the bank under the loan agreement. Two competing banks have offered to replace Busch Corporationâ€™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 Corporationâ€™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 Corporationâ€™s annual costs under each loan agreement, including interest and costs for the CPA firmâ€™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.
d . Discuss why Busch may desire to have an audit, ignoring the potential reduction in interest costs.
e . Explain how a strategic understanding of the clientâ€™s business may increase the value of the audit service.