Repayment Schedule Term loans are usually repaid in installments either monthly, quarterly,

Repayment Schedule Term loans are usually repaid in installments either monthly, quarterly,

semiannually, or annually. Let’s look at the typical repayment schedule for a term loan. Suppose that GemOne Corporation is a manufacturer that seeks a 4-year term loan of $100 million. Let’s assume for now that the term loan carries a fixed interest rate of 8% and that level payments are made monthly. A “level payment” means that the same amount is paid each month. Thus, there will be 48 monthly payments. In a typical term loan, the payments are structured such that each month GemOne’s

Intermediate and Long-Term Debt

payment will include interest and principal repayment. A loan struc- tured in this way is what we refer to as an amortizing loan. The loan payments are determined such that after the last payment is made, there is no loan balance outstanding. Thus the loan is referred to as a fully amortizing loan.

For our hypothetical 4-year, $100 million term loan with an 8% rate, the monthly payment would be $2,441,292.23. This amount is determined by using the time value of money principles explained in Chapter 7. The procedure is to determine the amount of an annuity (i.e., the monthly loan payment) that will make the present value of 48 pay- ments of the annuity equal to $100 million using a discount rate of 0.66667%. (The 0.66667% discount rate is the annual interest rate of 8% divided by 12 since the loan repays monthly.)

Exhibit 15.1 shows for each month the amount of the beginning monthly balance, the interest payment for the month, the amount of the monthly payment applied to repayment of the principal (referred to as the scheduled principal repayment or the amortization), and the ending loan balance. A schedule such as that shown in Exhibit 15.1 is referred to as an amortization schedule. Notice that in our illustration, the end- ing loan balance is zero. That is, it is a fully amortizing loan.

Suppose instead that the term loan is still fixed at 8% for the 4-year life of the loan but that instead of fully amortized, GemOne seeks to lower its monthly payment by not fully amortizing the loan. Suppose that the lender agrees that it will accept a loan balance at the end of the

4 years of $10 million. The principal outstanding at the end of 4 years that must be paid is called a balloon payment. The amount of the monthly loan payment for such a loan would be $2,263,829.68. At the end of year 4, GemOne must make the last monthly loan payment of $2,263,829.68 plus the balloon payment of $10 million.

In an interest-only loan, no scheduled principal repayment is made each month prior to the last month of the loan’s term. Instead, each month interest is paid. In our GemOne 4-year term loan, the monthly interest is $666,666.67. This is simply the monthly interest rate of 0.66667% (8%/12) multiplied by the amount borrowed, $100 million. The payment at the end of the last year of the loan is the monthly inter- est payment of $666,666.67 plus the balloon payment of $100 million.

A loan structured in this way where no principal repayments are made during the life of the loan is called a bullet loan and the last payment is called a bullet payment.

So far we have looked at a fixed-rate term loan. Suppose that the GemOne loan is a floating-rate loan and the loan resets at the beginning of each one year anniversary of the loan. Assume that for the first year the loan rate is 8% and in the second year the loan rate increases to 10%. The

FINANCING DECISIONS

EXHIBIT 15.1 Term Loan Amortization Schedule: Fixed Rate, Fully Amortized Interest rate

$100,000,000 Number of months

Loan

48 Monthly payment

Ending Month

Beginning

Scheduled

Loan Balance

Interest

Principal Repayment Loan Balance

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monthly loan payment for the second year would be determined as follows. Assuming the loan is a fully amortizing loan, at the end of the first year we know what the outstanding loan balance is. This amount can be found in Exhibit 15.1. It is $77,906,042.97. Thus, GemOne is borrowing $77,906,042.97 for three years at the new rate, 10% per annum or 0.8333% per month. The monthly loan payment to fully amortize a 3-year 10% term loan is $2,513,808.87. Panel a in Exhibit 15.2 shows the amorti- zation schedule for the 12 months in the second year on the loan.

Let’s suppose in the third year of the term loan that the loan rate decreases to 9%. The loan balance at the end of the second year is $54,476,387.15 as can be seen from panel a in Exhibit 15.2. The monthly loan payment to fully amortize $54,476,387.15 for 2 years at 9% is $2,488,739.71. The amortization schedule for the third year is shown in panel b of Exhibit 15.2. At the end of the third year, the out- standing balance is $28,458,521.22. If in the fourth year the loan rate decreases to 7.8%, then the monthly loan payment necessary to fully amortize $28,458,521.22 for one year is $2,472,931.18. Panel c of Exhibit 15.2 shows the amortization schedule for the last year. Note that at the end of the fourth year the outstanding balance is zero; that is, the loan is fully amortized.

EXHIBIT 15.2 Amortization Schedule for a Term Loan with a Floating Rate:

Years 2 through 4 a. Year 2

Interest rate 10%

$77,906,043 Number of months

Loan

36 Monthly payment

Beginning Scheduled Ending Month

Loan Balance

Interest

Loan Repayment Loan Balance

FINANCING DECISIONS

EXHIBIT 15.2 (Continued) b. Year 3

Interest rate 9%

$54,476,387 Number of months

Loan

24 Monthly payment

Beginning Scheduled Ending Loan Month

Loan Balance

Interest

Loan Repayment Balance

c. Year 4

$28,458,521 Number of months

Interest rate 7.8%

Loan

12 Monthly payment

Beginning Scheduled Ending Month

Loan Balance

Interest

Loan Repayment Loan Balance

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