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
Intermediate and Long-Term Debt
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
Intermediate and Long-Term Debt
Parts
» Financial Management and Analysis
» SECURITIES MARKETS The primary function of a securities market—whether or not it has a
» Stock Exchanges Stock exchanges are formal organizations, approved and regulated by
» Stock Market Indicators Stock market indicators have come to perform a variety of functions,
» Efficient Markets Investors do not like risk and they must be compensated for taking on
» THE FEDERAL RESERVE SYSTEM The United States has a central monetary authority known as the Fed-
» The Fed and the Money Supply Financial managers and investors are interested in the supply and
» Deposit Institutions Traditionally, the United States has had several types of deposit institu-
» Investment Banking The primary market involves the distribution to investors of newly
» Interest Rates and Yields Because bonds are traded in the secondary market, the price of the bond
» The Risk Premium Market participants talk of interest rates on non-Treasury securities as
» OPTIONS An option is a contract in which the writer of the option grants the
» Buying Call Options The purchase of a call option creates a position referred to as a long call
» Buying Put Options The buying of a put option creates a financial position referred to as a
» CAP AND FLOOR AGREEMENTS There are agreements available in the financial market whereby one
» I n assessing a company’s current and future cash flows, the financial
» Depreciation for Tax Purposes For accounting purposes, a firm can select a method of depreciation
» Capital Gains We tend to use the term “capital gain” loosely to mean an increase in the
» Current assets (also referred to as circulating capital and working
» Noncurrent Assets Noncurrent assets are assets that are not current assets; that is, it is not
» Deferred Taxes Along with long-term liabilities, the analyst may encounter another
» THE INCOME STATEMENT An income statement is a summary of the revenues and expenses of a
» THE STATEMENT OF CASH FLOWS The statement of cash flows is a summary over a period of time of a
» T he notion that money has a time value is one of the most basic con-
» DETERMINING THE PRESENT VALUE Now that we understand how to compute future values, let’s work the
» Shortcuts: Annuities There are valuation problems that require us to evaluate a series of level
» THE CALCULATION OF INTEREST RATES
» T here are a number of factors that affect a stock’s price and its value to
» Dividend Valuation Model If dividends are constant forever, the value of a share of stock is the
» Returns on Common Stock As we saw in the preceding section, the value of a stock is the present
» Straight Coupon Bond Suppose you are considering investing in a straight coupon bond that:
» Returns on Bonds If you invest in a bond, you realize a return from the interest it pays (if
» Coupon Bonds The present value of a bond is its current market price, which is the dis-
» Callable Bonds Some bonds have a feature, referred to as a call feature, that allows the
» RISK Whenever you make a financing or investment decision, there is some
» Financial Risk When we refer to the cash flow risk of a security, we expand our con-
» Reinvestment Rate Risk Another type of risk is the uncertainty associated with reinvesting cash
» Interest Rate Risk Interest rate risk is the sensitivity of the change in an asset’s value to
» Currency Risk In assessing the attractiveness of an investment, we estimated future cash
» 5 (Continued) Portfolio of Investment C and Investment D
» Portfolio Size and Risk What we have seen for a portfolio with two assets can be extended to
» I n Chapters 8 through 10, we discussed and practiced techniques for
» The Cost of Debt Because Congress allows you to deduct from your taxable income the
» The Cost of Common Stock The cost of common stock is the cost of raising one more dollar of com-
» INTEGRATIVE EXAMPLE: ESTIMATING THE COST OF CAPITAL FOR DUPONT
» CAPITAL BUDGETING Because a firm must continually evaluate possible investments, capital
» Investment Cash Flows When we consider the cash flows of an investment we must also consider
» Asset Disposition At the end of the useful life of an asset, the firm may be able to sell it or
» Change in Expenses When a firm takes on a new project, the costs associated with it will
» Putting It All Together Here’s what we need to put together to calculate the change in the firm’s
» The Analysis To determine the relevant cash flows to evaluate this expansion, let’s
» The Problem The new equipment costs $300,000 and is expected to have a useful life of
» T he value of a firm today is the present value of all its future cash
» Payback Period The payback period for a project is the length of time it takes to get your
» Discounted Payback Period The discounted payback period is the time needed to pay back the origi-
» Net Present Value If offered an investment that costs $5,000 today and promises to pay
» Net Present Value Decision Rule
» Profitability Index The profitability index (PI) is the ratio of the present value of change in
» Stand-Alone versus Market Risk If we have some idea of the uncertainty associated with a project’s
» Sensitivity Analysis Estimates of cash flows are based on assumptions about the economy,
» Simulation Analysis Sensitivity analysis becomes unmanageable if we change several factors
» Options on Real Assets The valuation of stock options is rather complex, but with the assis-
» OVERVIEW OF DEBT OBLIGATIONS In a debt obligation, the borrower receives money in exchange for a
» Repayment Schedule Term loans are usually repaid in installments either monthly, quarterly,
» Interest In the United States, interest is typically paid twice a year at six month
» Debt Retirement By the maturity date of the bond, the issuer must pay off the entire par
» Rating Systems In all systems the term high grade means low default risk, or conversely,
» S uppose you buy a new car that costs $20,000 and you pay cash for it.
» Limited Liability The corporate form of doing business is attractive to owners of a busi-
» Stock Ownership We can classify a corporation according to whether its shares of stock
» Voting Rights Common shareholders are generally granted rights to
» Corporate Democracy Corporate democracy gives owners of the corporation a say in how to
» Methods of Repurchasing Stock
» Dividends Although a firm’s board of directors declares a dividend on its preferred
» Sinking Funds Because there is no legal obligation to pay the preferred dividend and
» DEBT VERSUS EQUITY The combination of debt and equity used to finance a firm’s projects is
» CAPITAL STRUCTURE AND TAXES We’ve seen how the use of debt financing increases the risk to owners;
» Interest Tax Shield An interesting element introduced into the capital structure decision is
» Unused Tax Shields The value of a tax shield depends on whether the firm can use an interest
» PUTTING IT ALL TOGETHER As a firm increases the relative use of debt in the capital structure, its
» A s we saw in Part Three, managers base decisions about investing in
» CASH MANAGEMENT Cash flows out of a firm as it pays for the goods and services it pur-
» The Baumol Model The Baumol Model is based on the Economic Order Quantity (EOQ)
» The Miller-Orr Model The Baumol Model assumes that cash is used uniformly throughout the
» The Check Clearing Process The process of receiving cash from customers involves several time-
» RECEIVABLES MANAGEMENT When a firm allows customers to pay for goods and services at a later
» Captive Finance Subsidiaries Some firms choose to form a wholly-owned subsidiary—a corporation
» The Economic Order Quantity Model The Economic Order Quantity (EOQ) model helps us determine what
» Just-in-Time Inventory The goal of the just-in-time (JIT) inventory model is to cut down on the
» Monitoring Inventory Management We can monitor inventory by looking at financial ratios in much the
» Add-on-interest Another way of stating interest is with add-on interest, where the total
» Trade Credit Trade credit is granted by a supplier to a customer purchasing goods or
» Commercial Paper Commercial paper is an unsecured promissory note with a fixed matu-
» Types of Inventory Financing There are several different types of loan arrangements that involve
» SPECIALIZED COLLATERALIZED BORROWING ARRANGEMENT FOR FINANCIAL INSTITUTIONS
» RATIOS AND THEIR CLASSIFICATION
» RETURN-ON-INVESTMENT RATIOS Return-on-investment ratios compare measures of benefits, such as earn-
» The Du Pont System The returns on investment ratios give us a “bottom line” on the perfor-
» LIQUIDITY Liquidity reflects the ability of a firm to meet its short-term obligations
» PROFITABILITY RATIOS We have seen that liquidity ratios tell us about a firm’s ability to meet its
» Using a Benchmark To interpret a firm’s financial ratios we need to compare them with the
» INTEGRATIVE EXAMPLE: FINANCIAL ANALYSIS OF WAL-MART STORES 6
» Dilutive Securities For a company having securities that are dilutive—meaning they could
» ANALYSTS’ FORECASTS There are many financial services firms offering projections on different
» PRICE-EARNINGS RATIO Many investors are interested in how the earnings are valued by the mar-
» FREE CASH FLOW Cash flows without any adjustment may be misleading because they do
» NET FREE CASH FLOW There are many variations in the calculation of cash flows that are used
» Using Cash Flow Information The analysis of cash flows provides information that can be used along
» THE GLOBAL ECONOMY Many countries export a substantial portion of the goods and services
» FOREIGN CURRENCY Doing business outside of one’s own country requires dealing with the cur-
» The Euro The European Union consists of 15 European member countries that
» Global Equity Market In 1985, Euromoney surveyed several firms that either listed stock on a
» Currency Swaps When issuing bonds in another country where the bonds are not denom-
» Currency Option Contracts In contrast to a forward or futures contract, an option gives the option
» A s an alternative to the issuance of a corporate bond, a corporation
» WHAT RATING AGENCIES LOOK AT IN RATING ASSET-BACKED SECURITIES
» Third-Party Guarantees Perhaps the easiest form of credit enhancement to understand is insur-
» EXAMPLE OF AN ACTUAL STRUCTURED FINANCE TRANSACTION
» Accounting for Capital Leases
» FEDERAL INCOME TAX REQUIREMENTS FOR TRUE LEASE TRANSACTIONS
» Direct Cash Flow from Leasing When a firm elects to lease an asset rather than borrow money to pur-
» S tructured financing is a debt obligation that is backed by the value of
» CREDIT IMPACT OBJECTIVE While the sponsor or sponsors of a project financing ideally would pre-
» A business that maximizes its owners’ wealth allocates its resources
» Budgeting In budgeting, we bring together analyses of cash flows, projected income
» Taxes and Transaction Costs The Black-Scholes option pricing model ignores taxes and transaction
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