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Lecture Fundamentals of financial management (13/e) - Chapter 21: Term loans and leases

In this chapter we examine various types of term debt as well as lease financing. After studying chapter 21, you should be able to: Describe various types of term loans and discuss the costs and benefits of each; explain the nature and the content of loan agreements, including protective (restrictive) covenants; discuss the sources and types of equipment financing; understand and explain lease financing in its various forms. | Chapter 21 Term Loans and Leases © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI Term Loans and Leases Term Loans Provisions of Loan Agreements Equipment Financing Lease Financing Evaluating Lease Financing in Relation to Debt Financing Term Loan -- Debt originally scheduled for repayment in more than 1 year, but generally in less than 10 years. Term Loans Credit is extended under a formal loan arrangement. Usually payments that cover both interest and principal are made quarterly, semiannually, or annually. The repayment schedule is geared to the borrower’s cash-flow ability and may be amortized or have a balloon payment. Costs of a Term Loan The interest rate is higher than on a short-term loan to the same borrower (25 to 50 basis points on a low risk borrower). Interest rates are either (1) fixed or (2) variable depending on changing market conditions -- possibly with a floor or ceiling. Borrower is also required to pay legal expenses (loan agreement) and a commitment fee (25 to 75 basis points) may be imposed on the unused portion. Benefits of a Term Loan The borrower can tailor a loan to their specific needs through direct negotiation with the lender. Flexibility in terms of changing needs allows the borrower to revise the loan more quickly and more easily. Term loan financing is more readily available over time making it a more dependable source of financing than, say, the capital markets. Revolving Credit Agreements Agreements are frequently for three years. The actual notes are usually 90 days, but the company can renew them per the agreement. Most useful when funding needs are uncertain. Many are set up so at maturity the borrower has the option of converting into a term loan. Revolving Credit Agreement -- A formal, legal commitment to extend credit up to some maximum amount over a stated period of time. Insurance Company Term Loans These term loans usually have . | Chapter 21 Term Loans and Leases © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI Term Loans and Leases Term Loans Provisions of Loan Agreements Equipment Financing Lease Financing Evaluating Lease Financing in Relation to Debt Financing Term Loan -- Debt originally scheduled for repayment in more than 1 year, but generally in less than 10 years. Term Loans Credit is extended under a formal loan arrangement. Usually payments that cover both interest and principal are made quarterly, semiannually, or annually. The repayment schedule is geared to the borrower’s cash-flow ability and may be amortized or have a balloon payment. Costs of a Term Loan The interest rate is higher than on a short-term loan to the same borrower (25 to 50 basis points on a low risk borrower). Interest rates are either (1) fixed or (2) variable depending on changing market conditions -- possibly with a floor or ceiling. .