Xavier Manufacturing and Zulu Products bothseek funding at the lowest possible cost. Xavier would prefer the flexibility of floating rate borrowing, whileZulu wants the security of fixed rate borrowing.  Xavier is the more credit-worthy company.They face the following rate structure. Xavier, with the better credit rating,has lower borrowing costs in both types of borrowing.

	Xavier	Zulu
Credit rating	AAA	BBB
Fixed rate cost of borrowing	8%	12%
Floating rate cost of borrowing	LIBOR+1%	LIBOR+2%

Xavier wants floating rate debt,so it could borrow at LIBOR+1%. However it could borrow fixed at 8% and swapfor floating rate debt. Zulu wants fixed rate, so it could borrow fixed at 12%.However it could borrow floating at LIBOR+2% and swap for fixed rate debt. Whatshould they do?

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