Vial-tek has an existing loan in the amount of \(\$ 3.5\) million with an annual interest rate of \(9.5 \%\). The company provides an internal company-prepared financial statement to the bank under the loan agreement. Two competing banks have offered to replace Vial-tek's existing loan agreement with a new one. First National Bank has offered to loan Vial-tek \(\$ 3.5\) million at a rate of \(8.5 \%\) but requires Vial-tek to provide financial statements that have been reviewed by a CPA firm. City First Bank has offered to loan Vial-tek \(\$ 3.5\) million at a rate of \(7.5 \%\) but requires Vial-tek to provide financial statements that have been audited by a CPA firm. The controller of Vial-tek approached a CPA firm and was given an estimated cost of \(\$ 20,000\) to perform a review and \(\$ 45,000\) to perform an audit.

Required

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 Vial-tek's annual costs under each loan agreement, including interest and costs for the CPA firm's services. Indicate whether Vial-tek should keep its existing loan, accept the offer from First National Bank, or accept the offer from City First Bank.

c. Assume that First National Bank has offered the loan at a rate of \(8.0 \%\) with a review, and the cost of the audit has increased to \(\$ 50,000\) due to new auditing standards requirements. Indicate whether Vial-tek should keep its existing loan, accept the offer from First National Bank, or accept the offer from City First Bank.

d. Discuss why Vial-tek may desire to have an audit, ignoring the potential reduction in interest costs.

e. Explain how a strategic understanding of the client's business may increase the value of the audit service.