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

question 47

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 #1 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:

Sunk Cost

Costs that have already been incurred and cannot be recovered or changed, and should not affect future business decisions.

Differential Analysis

The process of comparing the differences in cost and revenue between different business decisions or scenarios to help in decision making.

Differential Analysis

The process of comparing the costs and benefits of different business decisions or alternatives.

Markup Percentage

The percentage added to the cost of goods to cover overhead and profit, representing the difference between the cost of the product and its selling price.