© 2000 John Petroff
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© 2000 John Petroff |
A corporation can finance its vehicles and equipment with a term loan from a bank (or from other financial intermediaries prepared to make long term commercial loans). The length of the loan can be anywhere from three years to fifteen years, with most such loans being around five years. This is a simpler alternative to issuing a bond, but it is also more costly and more restrictive. The additional interest charged by banks can be anywhere from .10% to .50% over the cost of issuing a bond (flotation cost, coupon, bond discount, and other charges included). The restriction a lending bank may impose are in the form of mortgage on the asset, limitation of new borrowing, maintaining certain ratios (e.g. current, times-interest-earned and fixed charge coverage), regular and timely reporting of financial results. For some firms, especially small ones, issuing a bond is not possible, and bank loans (or leasing) are almost the only available alternatives. Small loans also regularly fetch 1% or 2% higher interest rates because of administration and investigation costs being spread over a smaller principal. Advantages of loans are: the loan can be issued faster, some flexibility can exist with regard to the terms of the loan which can be especially significant if the firm experiences unexpected difficulties later on, a relationship can be built with the lender so that trust will diminish future charges, the interest can be flexible (i.e. indexed to treasury bills or prime rate) rather than fixed as it is for almost all bonds.
See review questions Q-12E1.1 and Q-12E1.2.
See research assignment R-12E1.1.
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