Question

You work in a small to medium size business – your boss has just told you that he plans to take out a 5-10 year loan to pay for the short-term needs of the business because it is easier than any other loan in that he does it once and the money is in his bank account when he needs it. Using what you have learned about working capital management, explain some of the other alternatives that he has and why a long-term (5-10 year) loan may not be his best choice.

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One of the problems that the business may face is when interest rates go down in the future. For instance, if the rate of the long-term loan was contracted at 4%, and the interest rate become lower, say 2%, then the company is tied to a long-term liability with a high interest rate. This means that that its weighted average cost of capital will be so high for a long time, compared to the situation had the company just borrowed for a short term....

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