Pasu International purchased a plant in Louisiana on December 31, 2015, and financed $20,000,000 of the purchase price with a 5-year note. The note bears interest at the fixed rate of 5%, and payments on the note are made quarterly in the amount of $1,136,408. The note has a balance of $12,590,619 as of December 31, 2017. At the beginning of 2018, Pasu became concerned that variable or floating interest rates would be less than its fixed rate on the above note.
Given this concern, Pasu arranged an interest rate swap on a notional amount equal to the outstanding balance of the note at the beginning of each quarter beginning with the January 1, 2018, balance of the note. The swap calls for the payment of a variable or floating interest rate on the principal balance of the note to a counterparty in exchange for a fixed rate of 4.75%. The floating rate is LIBOR plus 1.5% and is reset at the beginning of each quarter for that quarter’s calculations.
In an unrelated transaction, on June 30, 2018, Pasu sold its plant in Europe and as part of the transaction received an 18-month $10,000,000 note receivable from the buyer. The note bears interest at a rate of LIBOR plus 2.0%, and interest-only payments are made each quarter during 2018. The floating rate is reset at the beginning of each quarter. Concerned that declining floating interest rates will decrease the value of the note, Pasu has arranged an interest rate swap with a counterparty effective July 1, 2018. The swap calls for the payment by Pasu of floating rate of LIBOR plus 1.7% in exchange for a fixed rate of 4.5%.
LIBOR rates at the beginning of each calendar quarter of 2018 are as follows:
January 1. . . . . . . . . . . . . . . . . . . . . . . . 3.25%
April 1 . . . . . . . . . . . . . . . . . . . . . . . . . . 3.15
July 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.90
October 1 . . . . . . . . . . . . . . . . . . . . . . . 2.65
Required
All interest rates are stated as annual interest rates. As of December 31, 2018, calculate each of the following:
1. Annual fixed interest paid on the note resulting from the purchase of the Louisiana plant.
2. Annual floating interest paid to the counterparty on the note resulting from the sale of the European plant.
3. Annual net interest expense on the note resulting from the purchase of the Louisiana plant.
4. Annual net interest income on the note receivable.
5. Assuming that the LIBOR rate at October 1, 2018, will continue into the future, determine the December 31, 2018, value of the interest rate swap associated with the note receivable.
6. If the note receivable had been denominated in Euros versus U.S. dollars, determine to what additional risks Pasu would have been exposed.