Carter Enterprises can issue floating-rate debt at LIBOR + 2% or fixed-rate debt

Question

Carter Enterprises can issue floating-rate debt at LIBOR + 2% or fixed-rate debt at 10%. Brence Manufacturing can issue floating-rate debt at LIBOR + 3.1% or fixed-rate debt at 11%. Suppose Carter issues floating-rate debt and Brence issues fixed-rate debt. They are considering a swap in whcih Carter makes a fixed-rate payment of 7.95% to Brence and Brence makes a payment of LIBOR to Carter. What are the net payments of Carter and Brence if they engage in the swap? Would Carter be better off if it issued floating-rate debt and engaged in the swap? Would Brence be better off if it issued floating-rate debt or if it issued fixed-rate debt and engaged in the swap?

Explanation / Answer

What are the net payments of Carter and Brence if they engage in the swap?

Would Carter be better off if it issued fixed-rate debt or if it issued floating-rate debt and engaged in the swap?

If engaged in a swap, the net payments would be:

Carter Enterprises Payment to Lender LIBOR 2.00%

Payment to Swap Counterparty 7.95%

Payment from Swap Counterparty –

LIBOR ----------------------------------------------------------------------------------

Net Payment 9.95%

Fixed Brence Manufacturing Payment to Lender 11.00% Payment to Swap Counterparty -7.95%

Payment from Swap Counterparty + LIBOR ----------------------------------------------------------------------------------Net Payment LIBOR + 3.05%

Floating Carter would be better off if they issued floating-rate debt and engaged in a swap Brence would be better off it if issued fixed-rate debt and engaged in a swap.

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