The Banisco Corporation is negotiating a contract to borrow $300,000 to be repaid in a lump sum at the end of nine years. Interest payments will be made on the loan at the end of each year. The company is considering the following three financing arrangements:

• The company can borrow the money using a fixed rate loan (FRL) that requires interest payments of 9% per year.

• The company can borrow the money using an adjustable rate loan (ARL) that requires interest payments of 6% at the end of each of the first five years. At the beginning of the sixth year, the interest rate on the loan could change to 7%, 9%, or 11% with probabilities of 0.1, 0.25, and 0.65, respectively.

• The company can borrow the money using an ARL that requires interest payments of 4% at the end of each of the first three years. At the beginning of the fourth year, the interest rate on the loan could change to 6%, 8%, or 10% with probabilities of 0.05, 0.30, and 0.65, respectively. At the beginning of the seventh year, the interest rate could decrease by 1 percentage point with a probability of 0.1, increase by 1 percentage point with a probability of 0.2, or increase by 3 percentage points with a probability of 0.7.

a. Create a decision tree for this problem, computing the total interest paid under each possible scenario.

b. Which decision should the company make if it wants to minimize its expected total interest payments?