1. Duncan Brooks needs to borrow $500,000 to open new stores. Brooks can borrow

Question

1. Duncan Brooks needs to borrow $500,000 to open new stores. Brooks can borrow $500,000 by issuing 5%, 10-year bonds at a price of 96. How much will Brooks actually receive in cash under this arrangement? How much must Brooks pay back at maturity? How will Brooks account for the difference between the cash received on the issue date and the amount paid back?
2. Brooks prefers to borrow for longer periods when interest rates are low and for shorter periods when interest rates are high. Why is this a good business strategy?

Explanation / Answer

1. Brooks will receive 96% of 500,000 or 480,000. Brooks will pay back the 500,000 at maturity. Brooks will amortize the discount over the life of the loan. 2. Because when interest rates are low and you get a longer loan, then if interest rates go up, you still have the low rates. If the cost of borrowing is cheap enough, you may not want to pay it back right and away and keep paying the interest. Also when interest rates are higher, you're probably going to want to pay off the loan sooner to avoid paying a lot in interest, and you may want to get a new loan if the interest rates drop.

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