Term Loan Versus Coupon Bond
Bingo Corporation is determining whether to support $150,000 of its permanent current assets with a bank note or a short-term bond. The firm's bank offers a two year note where the firm will receive $150,000 and repay $175,000 at the end of two years. The firm has the option to renew the loan at market rate. Alternatively, Bingo can sell 8.5% coupon bonds with a 2-year maturity and $1,000 par value at a price of $973.97. How many percentage points lower is the interest rate on the less expensive debt instrument?
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Solution Preview
The first loan is a term loan. That is, the borrower receives a lump-sum today and pays a lump-sum (which includes principal and interest) at some future date. It is analogous ...
Solution Summary
Using an Excel spreadsheet, this solution illustrates how to determine the effective interest rate of a coupon bond sold at a discount and how to compare that cost to the interest cost of a bank loan issued at an original issue discount (i.e., receive a lump sum now and repay a greater lump sum later).