Instruction 9.1: For the Following Problem(s), Consider These Debt Strategies Being Considered

question 24

Multiple Choice

Instruction 9.1:
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 9.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)

• A)Your credit rating stayed the same and interest rates went up.
• B)Your credit rating stayed the same and interest rates went down.
• C)Your credit rating improved and interest rates went down.
• D)Not enough information to make a judgment.

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Definitions:

Net Operating Income

The total profit of a company after operating expenses are deducted, but before interests and taxes are subtracted.

Fixed Cost

Costs that do not change with the level of production or sales activity, such as rent or salaries.

Segment Margin

The amount of profit or loss produced by a particular segment of a business, considering only the revenues and expenses directly attributable to that segment.

Contribution Margin

The difference between sales revenue and variable costs, indicating how much revenue contributes to fixed costs and profit.