Instruction 8.1: For the Following Problem(s), Consider These Debt Strategies Being Considered

question 17

Multiple Choice

Instruction 8.1:
For the following problem(s) , consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #2 will:

• A) guarantee the lowest average annual rate over the next three years.
• B) eliminate credit risk but retain repricing risk.
• C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
• D) preclude the possibility of sharing in lower interest rates over the three-year period.

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Definitions:

Publicly-traded Domestic Corporation

A company registered in the U.S. that sells its stocks to the public on at least one stock exchange.

DRD

Dividends-Received Deduction, a tax deduction received by a company for the dividends it gets from its investments in other companies.

AMT

The Alternative Minimum Tax, a parallel tax system in the United States designed to ensure that individuals and corporations pay at least a minimum amount of taxes.

Small Corporations

Businesses typically characterized by a limited number of shareholders, assets, and revenues, and may qualify for certain tax benefits and simpler regulations.