Lluvia and Paraguas. Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would prefer the flexibility of floating-rate borrowing, while Paraguas wants the security of fixed-rate borrowing. Lluvia isthe more creditworthy company. They face the following rate structure. Lluvia, with the better credit rating, has lower borrowing costs in both types of borrowing. Lluvia wants floating-rate debt, so it could borrow at LIBOR + 1.000%. However, itcould borrow fixed at 8.500% and swap for floating-rate debt. Paraguas wants fixed-rate debt, so it could borrow fixed at 12.500%. However, it could borrow floating at LIBOR +2.000% and swap for fixed-rate debt. What should they do? (LIBORis 5.500%.)Lluvia's comparative advantage is %. (Round three decimal places.)

In case of interest rate swap, two parties exchange their interest rates for the same notional…

Answered: Lluvia and Paraguas. Lluvia…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

See similar textbooks

Similar questions

Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would prefer the flexibility of floating-rate borrowing, while Paraguas wants the security of fixed-rate borrowing. Lluvia is the more creditworthy company. They face the following rate structure. Lluvia, with the better credit rating, has lower borrowing costs in both types of borrowing. Lluvia wants floating-rate debt, so it could borrow at LIBOR+1.000%. However, it could borrow fixed at 8.500% and swap for floating-rate debt. Paraguas wants fixed-rate debt, so it could borrow fixed at 12.500%. However, it could borrow floating at LIBOR+2.000% and swap for fixed-rate debt. What should they do? (LIBOR is 5.500%.) Lluvia's comparative advantage is % (round 3 decimals) Paraguas's net interest after a swap with Lluvia is (round 3 decimals) Lluvia's savings on borrowing versus net swap is (round 3 decimals) Paraguas's savings on borrowing versus net swap is (round 3 decimals)
An analyst at a company notes that its cost of debt is far below that of equity. He concludes that it is important for the firm to maintain the ability to increase its borrowing because if it cannot borrow, it will be forced to use more expensive equity to finance some projects. This might lead it to reject some projects that would have seemed attractive if evaluated at the lower cost of debt. How do you balance the amount of equity and debt? Explain the significance of maintaining the ability to increase borrowing capacity for a company with a lower cost of debt compared to equity. How does this impact project evaluation and investment decisions, and what role does the concept of cost of capital play in such considerations?
Firms require capital to invest in productive opportunities. The best firms with the most profitable opportunities can attract capital away from inefficient firms with less profitable opportunities. Investors supply firms with capital at a cost called the interest rate. The interest rate that investors require is determined by several factors, including the availability of production opportunities, the time preference for current consumption, risk, and inflation. Suppose the Federal Reserve (the Fed) decides to tighten credit by contracting the money supply. Use the following graph by moving the black X to show what happens to the equilibrium level of borrowing and the new equilibrium interest rate. S2 S1 16 D Equilibrium INTEREST RATE, r (Percent)
Company A desires a fixed-rate loan but currently has a better deal from the variable-rate market at a rate of SOFR+.03. If Company A borrows from the fixed-rate market, the cost would be .17. In contrast, Company B, which prefers a variable-rate loan, has a better deal from the fixed- rate market at .12. If Company B borrows from the variable-rate market, the cost would be SOFR+.02. Knowing both companies' needs, Bank C designed a swap deal. The deal is outlined in the following: Company A obtains a variable-rate loan at SOFR+.03. 2) Company B obtains a fixed-rate loan at .12. 3) Company A pays Bank C a fixed rate of .15 and receives a variable rate of SOFR+.02 from the bank. 1) 4) Company B pays Bank C a variable rate of SOFR+.04 and receives a fixed rate of .16 from the bank. How much is the cost saving to Company A?
Show that the Ricardian Equivalence does not necessarily hold if the assumption of perfect credit markets is violated which means the consumers can be liquidity constrained (e.g. due to transaction cost). More precisely, demonstrate the problem in a situation when the interest rate depends on whether the household lends or borrows in the first period. Lenders get an interest rate is rL, while borrowers face an interest rate rB, with rB > rL. Government can also borrow at the lower interest rate.
The Modigliani and Miller theories are based on several unrealistic assumptions about debt financing. In reality, there are costs, taxes, and other factors associated with debt financing. These costs or effects have led to several theories that explain the impact of these factors on the capital structure of a firm. Based on your understanding of the trade-off theory, what kind of firms are likely to use more leverage? Firms with a higher proportion of fixed-versus-variable costs Firms with a higher proportion of variable-versus-fixed costs Based on your understanding of the capital structure theories, identify the best option for the missing part of the statement. According to signalling theory, if managers expect the firm's stock price to decrease, they are ???? to raise capital through equity financing. Discouraged Encouraged According to the windows of opportunity theory, managers ???? in efficient markets. O Don't believe Believe Under the pecking-order hypothesis, a firm will…
Agency costs of debt arise any time there is a conflict between lender interests and borrower interests. Assuming that agency costs of debt are high at a company relative to the rest of the market, other things being equal, which of the following would you expect to observe with the company's borrowing? It will be able to borrow less than other companies. AND It will have to pay lower interest rates on its loans than otherwise companies. It will have to pay lower interest rates on its loans than otherwise similar companies. It will have to pay lower interest rates on its loans than otherwise similar companies. AND It will face more "covenants" than otherwise similar companies. NONE. it will face more "covenants" than otherwise similar companies. It will be able to borrow less than other companies. It will be able to borrow less than other companies. It will face more "covenants" than otherwise similar companies.
The market for capital Firms require capital to invest in productive opportunities. The best firms with the most profitable opportunities can attract capital away from inefficient firms with less profitable opportunities. Investors supply firms with capital at a cost called the interest rate. The interest rate that investors require is determined by several factors, including the availability of production opportunities, the time preference for current consumption, risk, and inflation. Suppose the Federal Reserve (the Fed) decides to tighten credit by contracting the money supply. Use the following graph by moving the black X to show what happens to the equilibrium level of borrowing and the new equilibrium interest rate. Q1. Which tend to be more volatile, short- or long-term interest rates? Long-term interest rates 2. Short-term interest rates Q2. If the inflation rate was 3.20% and the nominal interest rate was 4.20% over the last year, what was the real rate of interest over…
We think of banks as being interest rate intermediaries. That is, the borrow cheaply, and then lend at higher rates, and the spread between those is their profit. But, besides interest rates, what other sorts of risks do banks face?
Assume a Modigliani and Miller economy. Company XYZ is currently financed only withequity. The management of the company hires a consultant. The consultant makes thefollowing suggestion: “My advice for XYZ is to issue debt and use it to repurchase some ofthe company’s equity. This would allow XYZ to get the benefit of a low cost of capital ofdebt without raising its cost of capital of equity.”Discuss in detail the statement of the consultant.
Which of the following statements are incorrect regarding how much debt a company should borrow? Choose all that apply. Question 9 options: A As long as the company can generate higher returns on its new projects than its borrowing interest rate, borrowing more debt will enhance the company's ROE. B Borrowing more debt will increase a company's distress level. C The bigger the company, the more it should borrow D Debt is considered a more expensive capital source.
From the point of view of the borrowing business, loan capital tends to be cheap but risky. In what sense is it risky?

SEE MORE QUESTIONS

Recommended textbooks for you

Essentials Of Investments

Finance

ISBN:

9781260013924

Author:

Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:

Mcgraw-hill Education,

FUNDAMENTALS OF CORPORATE FINANCE

Finance

ISBN:

9781260013962

Author:

BREALEY

Publisher:

RENT MCG

Financial Management: Theory & Practice

Finance

ISBN:

9781337909730

Author:

Brigham

Publisher:

Cengage

Essentials Of Investments

Finance

ISBN:

9781260013924

Author:

Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:

Mcgraw-hill Education,

FUNDAMENTALS OF CORPORATE FINANCE

Finance

ISBN:

9781260013962

Author:

BREALEY

Publisher:

RENT MCG

Financial Management: Theory & Practice

Finance

ISBN:

9781337909730

Author:

Brigham

Publisher:

Cengage

Foundations Of Finance

Finance

ISBN:

9780134897264

Author:

KEOWN, Arthur J., Martin, John D., PETTY, J. William

Publisher:

Pearson,

Fundamentals of Financial Management (MindTap Cou…

Finance

ISBN:

9781337395250

Author:

Eugene F. Brigham, Joel F. Houston

Publisher:

Cengage Learning

Corporate Finance (The Mcgraw-hill/Irwin Series i…

Finance

ISBN:

9780077861759

Author:

Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor

Publisher:

McGraw-Hill Education

SEE MORE TEXTBOOKS