Problem 14.2
Adelaide Corporation
Compare the alternatives and make a recommendation.
Assumptions
Values
Principal borrowing need
$30,000,000
Maturity needed, in years
2.00
Fixed rate, 2 years
5.000%
Floating rate, six-month LIBOR + spread
Current six-month LIBOR
3.500%
Spread
1.500%
Fixed rate, 1 year, then re-fund
4.500%
First 6-months
Second 6-months
Third 6-months
Fourth 6-months
#1: Fixed rate, 2 years
Interest cost per year
$1,500,000
$1,500,000
Certainty over access to capital
Certain
Certain
Certain
Certain
Certainty over cost of capital
Certain
Certain
Certain
Certain
#2: Floating rate, six-month LIBOR +
spread
Interest cost per year
$750,000.00
$750,000.00
$750,000.00
$750,000.00
Certainty over access to capital
Certain
Certain
Certain
Certain
Certainty over cost of capital
Certain
Uncertain
Uncertain
Uncertain
#3: Fixed rate, 1 year, then re-fund
Interest cost per year
$1,350,000.00
???
???
Certainty over access to capital
Certain
Certain
Uncertain
Uncertain
Certainty over cost of capital
Certain
Certain
Uncertain
Uncertain
Only alternative #1 has a certain access and cost of capital for the full 2 year period.
Alternative #2 has certain access to capital for both years, but the interest costs in the final 3 of 4 periods is uncertain.
Alternatvie #3, possessing a lower interest cost in year 1, has no guaranteed access to capital in the second year.
Depending on the company's business needs and tolerance for interest rate risk, it should choose between #1 and #2.