You are an employee of a large manufacturing company that was created 30 years ago. This company was initially financed with an equity investment by some individuals. Overtime, the company has obtained substantial loans from commercial banks. The interest rate on the loans is tied to market interest rates, and is adjusted by the banks depending on the level of market interest rates. The company has a credit line with a bank in case it suddenly needs to obtain funds for a temporary period. It has also purchased Treasury securities that it could sell if it experiences any liquidity problems. In addition, the company has assets valued at about RM150 million and generates sales of about RM200 million per year. Some of its growth is attributed to its acquisitions of other firms. Because of its expectations of a strong economy, the company plans to grow in the future by expanding its business and through acquisitions. It expects that it will need substantial long-term financing, and plans to borrow additional funds either through loans or by issuing bonds. It is also considering the issuance of stock to raise funds in the next year. The company closely monitors conditions in financial markets that could affect its cash inflows and cash outflows and therefore affect its value. The company you work with relies heavily on commercial banks for loans. When the company was first established with equity funding from its owners, it easily obtained debt financing, as the financing was backed by some of the firms assets. However, as the company expanded, it continually relied on extra debt financing, which increased its ratio of debt to equity. Some banks were unwilling to provide more debt financing because of the risk that the company would not be able to repay additional loans. A few banks were still willing to provide funding, but they required an extra premium to compensate for the risk.

a. The loans provided by commercial banks to the company required that the company receive the banks approval from them before pursuing any large projects. What is the purpose of this condition? Does this condition benefit the owners of the company?

b. Given the companys expectations, do you think that it expects interest rates to increase or decrease in the future? Explain.

c. If the companys expectations of future interest rates are correct, how would this affect its cost of borrowing on its existing loans and on future loans?

d. Explain why the companys expectations about future interest rates may affect its decision about when to borrow funds and whether to obtain floating-rate or fixed-rate loans.