Understanding corporate finance: raising finance: the cost of borrowing
The return to the investor
Companies usually have to pay for the funds they borrow. This is the return to the investor. A company might be able to negotiate terms and there are many commercial considerations that might have an influence on them. For example, if cash flow is an important consideration and the company is confident that it will have a steady flow of income throughout the term of the loan, it might opt for a loan with interest payments monthly or quarterly. If the company is just starting up, it might have little income at the outset, but expect to have more income later; a loan with interest payments monthly or quarterly might then be difficult to service.
A company can borrow
- at interest (CFM11090)
- at a discount or premium (CFM11100)
- with a convertible, or asset-linked, debt (CFM11110)
- using alternative finance arrangements (CFM11120).
Effect of risk on returns
- The rates being charged in the market. If the banks are lending at 5% a company with a good credit rating is unlikely to be asked to pay, say, 12% for its borrowings.
- The security that is offered for the debt.