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(^364) Financial Management
periodic sheets, income statements, cash budgets and sources, and uses of funds
statements. This allows the lender to monitor the borrowerís financial condition and to
take or suggest corrective actions when needed.
Finally, the term loan agreement may also require the borrower to not make changes in
its executive ranks without the lenderís permission. The lender may also require sufficient
life insurance on the borrowerís key managerial personnel. These provisions are designed
to protect the lender from losses resulting from unforeseen changes in the borrowerís
important personnel.
Repaying Term Loans
Term loans are generally repaid on a periodic, systematic basis. Term lenders prefer
this procedure because it enhances the borrowerís capability to repay the loan. A large
lump-sum loan repayment at maturity may place a heavy financial burden on the borrower,
whereas with small periodic payments the borrower is not unduly financially burdened.
A second reason for amortising loans has to do with the use of funds from the loans.
Term loans are usually obtained for purchasing equipment. Loan amortisations are
more desirable because loan repayments can be geared to the cash flows being
generated by the equipment.
In this section two different loan amortisation procedures will be considered full
amortisation and one that results in a balloon payment.
Full Amortisation. Under full amortisation, the borrower makes periodic payments
until the loan and interest is fully paid. To explain the example cited previously, assume
that Central Manufacturing Corporation borrows Rs 800,000 for 10 years at an interest
rate of 9 per cent. The interest rate is the effective interest rate on the remaining
balance. In addition, the bank making this term loan requires that the loan be repaid in
10 equal installments which would include interest as well as payment on the principal.
The annual payment required to repay this loan can be determined by using Equation. 8,
which we renumber 1 for convenience.
PO = P ◊ IFAPn/i (1)
where P 0 is the present value of an annuity of P rupees receive every year for N years
and discounted at one per cent. In the term loan situation the annual payment is P
rupees and is found by
P = PO ◊ IFAn/i (2)
In the example cited, PO is Rs 800,000. The annuity factor, rounded off to four decimal
places, for Re 1 received every year for 10 years and discounted at 9 per cent is shown
as 6,4177 in Appendix B. Then P is