Assume Company L Wants to Pay a Floating Rate and Company

question 21

Essay

Assume company L wants to pay a floating rate and company N wants to pay a fixed rate.Company L is quoted 11% fixed-rate financing or a floating rate of LIBOR + 0.3%.In contrast, company N is quoted a fixed-rate financing at 14% and a floating rate financing at LIBOR + 0.75%.Calculate the net savings (%)to both parties if a swap is entered into between L and N if N pays L 12.0% and L pays N LIBOR.

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Definitions:

Shutdown Quantity

The amount of output at which a company's revenue just covers its variable costs, prompting it to cease operations temporarily if prices fall below this level.

Monopolistically Competitive

This refers to a market structure where many companies sell products that are similar but not identical, allowing for some degree of market power and product differentiation.

Economic Profit

The difference between a firm's total revenues and its opportunity costs, representing the additional gain over what could have been earned in the next best alternative.

Normal Profit

The minimum level of earnings needed for a company to remain in business, often considered as the company's opportunity cost.