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FIN.10:5 - Archetypal Grounding

Two constructed one-year offers finance a net need of 100. A charges 8% interest on face value and withholds an issue fee of 2% of face value. B charges 9% and no fee. Assume no other cost, tax difference or contingent term and that A permits the necessary larger face amount. A must issue 100/0.98 = 102.04 and repay 102.04×1.08 = 110.20; its effective cost is 1.08/0.98−1 = 10.20%. B provides 100 and repays 109, so B is cheaper for this need despite its higher headline rate. If A is capped at face value 100, its net proceeds of 98 do not meet the need at all.

FIN.10:5.1 - The same rate can provide different payment capacity

A separate corporation must pay 100 for an investment now and retain its existing cash reserve of 10. Two actually offered loans each deliver 100 net now, with no fees, tax differences or other restrictions. Both charge 10% annually on outstanding principal. Loan A repays 50 of principal at each year end; its payments are 60 in year 1 and 55 in year 2. Loan B pays interest 10 in year 1 and principal plus interest 110 in year 2. The investment and the rest of the business together provide cash of 28 and 115 at those year ends after every nonfinancing requirement. No additional source is available and no earlier shortfall occurs.

Loan A would leave 10 + 28 − 60 = −22 in year 1. Its nominal interest total of 15 does not make it usable. Loan B leaves 28 after year 1 and 33 after year 2, so it preserves the reserve at both dates. At a 10% comparison rate, each payment schedule has present value 100: 60/1.10 + 55/1.10² equals 10/1.10 + 110/1.10². The difference is the timing of principal use, not a lower effective rate.

If operating receipts move so that available cash becomes 60 in year 1 and 83 in year 2, preserving the total 143, Loan A leaves 10 and then 38. Both schedules now fit. Comparing their remaining cash requires the use and return of any interim surplus; comparing the final balances alone ignores that Loan B leaves more cash available after year 1. A decision to prefer one must therefore state that use or the relevant flexibility, not merely count interest.

FIN.10:5.2 - The holder of a financing right changes the dependable horizon

In a separate constructed case, the company has cash 10, a required reserve of 5 and an investment payment of 100 now. Each offered loan supplies 100 net before that payment. The investment produces net cash 112 at month 12, with no interim receipt or other cash difference. Interest of 3 is payable at month 6; if the principal remains outstanding, another 3 is payable at month 12. Compare three stipulated versions, with no fees or other acceleration condition:

  • The principal is due at month 6, but the borrower can extend it to month 12 by giving notice by the end of month 5. Timely notice is sufficient under the agreement; lender consent is not required.
  • The same extension requires the lender’s affirmative consent by the end of month 5. The borrower’s request alone does not extend the loan.
  • The stated maturity is month 12, but the lender may require repayment at month 6 by giving notice by the end of month 5.

After the initial draw and investment, cash remains 10. With the first version and a valid extension notice, the month-6 interest leaves 7. At month 12, cash becomes 7 + 112 − 100 − 3 = 16. The borrower’s exercisable right supplies the required horizon on the stated conditions.

For the second version without obtained consent, or the third after the lender’s call, month 6 requires principal and interest of 103. Preserving the reserve needs 103 + 5 − 10 = 98 of replacement net proceeds by that date. The positive month-12 investment return cannot pay this earlier maturity. Before committing, the company needs an arrangement that covers that branch, a different initial instrument or a changed investment plan. It cannot choose the lender’s future action as though that were its own extension option.

Suppose a separate replacement commitment is actually obtained by month 5 and supplies 98 net before the month-6 repayment, with conditions already satisfied and repayment of 103 at month 12. The month-6 account is 10 + 98 − 103 = 5; the final account is 5 + 112 − 103 = 14. This arrangement makes the early-repayment branch feasible on the given premises. If its proceeds instead settle after the old loan falls due, the arrangement does not repair the maturity gap.

These timelines establish dated availability and the resulting payments. Pricing the contingent rights is a further question requiring the qualified valuation grounds in FIN.8; the difference between final cash balances is not itself a price for an extension or call. FDM.3 supplies the actual notice, consent and claim events; FIN.2 tests their settlement order.

FIN.10:5.3 - Equity finance prices a transferred interest

In another constructed offer, the existing equity is worth 200 immediately before financing. A new investor supplies 100 net, with no fees or special rights, and the cash is added to the business without any other value change. Equal ordinary interests imply post-money equity value 300. Issuing one third of that equity to the investor leaves the old owners with two thirds worth 200. If the investor instead requires 40% on these same valuation grounds, the old owners retain 60% of 300, or 180: a transfer of 20 relative to their starting interest.

This is a valuation comparison of the offer, not a claim that an investor must accept one third. A changed business value, funding urgency, preference or control right changes the comparison. If the cash funds an investment with its own gain, first include that attainable gain consistently; do not credit it wholly to old owners and also use it to justify the new investor’s percentage.