Long Term Financing

Long Term Financing - Long-Term and Intermediate Debt...

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Long-Term and Intermediate Debt Financing for Firms I. A term loan , or intermediate-term credit, is defined as any debt obligation having an initial maturity between one and ten years. A. Term loans are available from a wide variety of sources including banks, insurance companies, pension funds, small business investment companies, government agencies and equipment suppliers. B. Particularly in smaller amounts, term loans are usually less expensive than issuing bonds or common stock. C. Term loans are often better suited for financing than short-term loans because of a reduction of the problems of future interest rate variability and ability to renew the loan. This is particularly true for financing small additions to plant and equipment where the cash flows from the investment often cover the servicing requirements of the debt. D. Term loans can also be used to finance moderate increases in working capital if the length of the loan approximately matches the time the working capital will be needed or until the debt can be amortized out of earnings. E. Term loans may require that the principal be amortized over the life of the loan. Amortization requires that the borrower make regular periodic payments of principal and interest. 1. A common arrangement is for the borrower to make regular equal payments so that the present value of the annuity of payments is equal to the amount of the loan. 2. Another arrangement calls for equal reductions in principal during the life of the loan together with payment of interest on the outstanding balance. 3. Partial amortization may be used which results in a lump payment called a "balloon payment" at the maturity of the loan. 4. Term loans may call for periodic payment of interest with a final balloon payment equal to the amount of the loan (bullet loan). This agreement is the most advantageous for firms. 1
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F. Interest costs on term loans depend on a number of factors—particularly, the general level of interest rates. Some intermediate loans have variable interest rates. Variable rates dependent on the prime rate or another indicator are sometimes used. Many have fixed rates of interest. G. Term loan agreements often call for the borrower to keep a percentage of the loan balance on deposit as a compensating balance. This can increase the effective interest rate on the loan. Compensating balances raise the effective cost of interest of the loan.
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This note was uploaded on 04/20/2011 for the course FIN 4181 taught by Professor Spencer during the Spring '11 term at Dowling.

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Long Term Financing - Long-Term and Intermediate Debt...

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