A bank manager advises all of his loan officers that the average cost of funds for the bank over the past year has been 6%. The bank has borrowed $1 million at 5%, another $1 million at 6% and another $1 million at 7%. Future borrowing costs are expected to continue at 7%. The manager however, instructs his loan officers that they are authorized to make loans at interest rates that are equal to or greater than the bank’s average cost of borrowing. How would you evaluate the bank manager’s decision?

To evaluate the bank manager's decision, we need to calculate the average cost of borrowing for the bank based on the given information and compare it with the future borrowing costs. Here's how you can do it step by step:

1. Calculate the total borrowed amount: $1 million + $1 million + $1 million = $3 million.

2. Calculate the weighted average cost of funds for the bank over the past year:
- Multiply the borrowed amount by the respective interest rate for each loan:
$1 million * 5% = $50,000
$1 million * 6% = $60,000
$1 million * 7% = $70,000
- Add up the costs: $50,000 + $60,000 + $70,000 = $180,000
- Divide the total cost by the total borrowed amount: $180,000 / $3 million = 0.06 or 6%.
Therefore, the average cost of borrowing for the bank over the past year is 6%.

3. Compare the average cost of borrowing (6%) with the expected future borrowing costs (7%):
- The manager has instructed loan officers to make loans at interest rates equal to or greater than the bank's average cost of borrowing. In this case, the average cost is 6%.
- The future borrowing costs are expected to continue at 7%.

Based on this evaluation, the bank manager's decision is reasonable. By authorizing his loan officers to make loans at interest rates equal to or greater than the bank's average cost of borrowing (6%), he ensures that the interest rates charged on loans will cover the expected future borrowing costs (7%). This helps the bank maintain profitability and effectively manage its future borrowing expenses.