Chapter 05

Intermediate Term Financing

Definition:

Relating to an investment with an expected holding period somewhere between short-

term and long-term. For bonds, collectibles, and real estate, intermediate-term usually
refers to a holding period that ranges between one and seven years. For stocks,
intermediate-term indicates a somewhat shorter period of six months to several years. For
futures and options contracts, intermediate-term ranges from one month to several
months.

Required amount of fund collected by a business enterprise for meeting up fund

requirement for acquiring important useable items and making investment from different
available sources for more than one year but less than 10 years’ time period is known as
intermediate term financing.
Features/ Characteristics of Intermediate Term Financing:
Normally any finance having maturity of more than one year but less than five years its consider
intermediate/medium/term financing. It has some characteristics which are given bellow:

Maturity: The maturity of Intermediate Term Financing is seven to ten years but in Bangladesh it is three to seven
years.
Size of Loan: Generally the amount of Intermediate Term Finance is tiny amount and it should be paid within the 3-7
years.
User of the Financing: Small, large and medium all types of company should be use Intermediate Term Financing. But
generally, the company who are not eligible to issue share and debenture.
Objectives of Credit: Generally to meet the current liability, purchases of machinery, sometimes expansion and
development of building are the main objectives of Intermediate Term Financing.
Sources: The commercial bank, Insurance Company, leasing firm and other non bank financial institution are the
sources of Intermediate Term Financing.
Intermediate Term Financing should be repayment with installment.
Security provisions are available in the Intermediate Term Financing.
Cost of Financing: In Intermediate Term Financing, interest rate is higher than short term financing but lower than long
term financing. But, if anyone wants to use lease then cost are always higher.
Flexibility is offered in an Intermediate Term Financing.
Intermediate Term Financing is renewable.
 Types of intermediate/medium/term finance:

1. Bank term loan: Normally the commercial banks provides term loan for a period of one year or
more and it is back by repayment schedule.
2. Revolving Credit: Revolving credit has two element of cost. One is regular interest on the
withdrawn portion and another is commitment fees that means undrawn portion.
3. Insurance company’s term loan: Insurance company could also be provides term loan.
4. Equipment financing: Any method of extending capital to businesses for the purpose of
acquiring equipment. Financing methods include equipment leasing, SBA and other government
loans, as well as sale-leaseback wherein the collateralized existing equipment to raise cash for
additional purchases.
 Advantages of intermediate-term financing:
 Flexibility: the borrower can get loan as his/her need.
 Low cost: cost is less than long-term financing.
 Convenience in repayment: the borrower can repay the loan as installment or at a time.
 Renewable: if the borrower fails to repay installment, the loan repayment period can be expand.
 Maintaining secrecy
 Goodwill for the borrower
 Rapid financing: collecting loan from capital market by selling share or debenture is time
consuming. So business collect intermediate-term credit in a short time.
 Control
 Only source for small business
 Get ownership of asset without capital
 Tax advantage
 Disadvantages of intermediate-term financing

 It is comparatively high cost than short-term financing.

 Inconvenience of installment payment if inflow of cash is decreasing.
 If borrower fails to repay installment, the lender collect money by selling borrower’s collateral
security.
 It is not easy to get loan for financially weak, small and new business. Because banks, financial
institutions give more afford to borrower’s financially solvency when considering loan.
 Sometimes lenders impose some restrictions over the borrower which limits the borrower’s power.
 The borrower is required to keep a portion of loan as compensating balance.
Methods of loan repayment:

Classes of Loan Repayment Method:

1. Balloon Method
2. Capital Recovery Method
 Balloon Payment
A balloon payment is basically a payment made to cover the outstanding principal. In other
words, the balance is due at maturity. The main benefit to a balloon payment is that
borrowers who don't have a large sum of money for a down payment have an alternative
option.
 Capital Recovery Method:
Under capital recovery the loan payments are made in several equal installments that includes interest
amount, which can be yearly, monthly, semi-annually and so on. In this method the amount of
installment payment is calculate with the help of the following formula:

Where, P= Principal Loan

A=Amount of Installment
R=Rate of Interest
N=No. of Period/Year
 Cost of intermediate term financing:
Problem:
A company needs Tk.30 lakh to finance a capital expenditure. Initially the company arranged for a revolving
credit agreement with Sonali Bank for 3 years on the condition that the agreement may be converted into
another 3 years term loan at the expiration of revolving credit commitment. The bank charges an interest rate of
2% over the prime rate for revolving credit and 3% over the prime rate for term loan. The commitment fee for
both credit arrangement is 1% of the unused portion. The company plans to borrow Tk.14 lakh at the beginning
and Tk. 10 lakh at the very end of the first year. At the exirition of the revolving credit agreement the company
plans to take down the full term loan. At the end of each of the fourth, fifth and sixth year it plans to make
principal payment of Tk. 10 lakh. The prime rate of interest is 9%.
a) What is the total cost of revolving credit for 3 year period? Find out the effective interest (EIR).
What is the cost of bank term loan for the 4th, 5th and 6th? Find out EIR also
 A)Cost of Revolving Credit
  Year 1 Year 2 Year 3
a) Actual amount of loan Tk.14,00,000 Tk.24,00,000 Tk.24,00,000
taken

a) Unused amount of loan 16,00,000 6,00,000 6,00,000

a) Interest on used 14,00,000×0.11=1,54,000 24,00,000×0.11=2,64,000 24,00,000×0.11=2,64,000

amount @ (9+2)=11%

a) Commitment fee on 16,00,000×0.01=16,000 6,00,000×0.01=6000 6,00,000×0.01=6000

unused portion@1%

a) =C+D 1,70,000 2,70,000 2,70,000

a) EIR
 B. Cost of Term Loan:
  Year 4 Year 5 Year 6
a) Amount of loan taken Tk.30,00,000 Tk.20,00,000 Tk.10,00,000

a) Unused amount of 10,00,000 20,00,000

loan 0

a) Interest on used 14,00,000×0.12 24,00,000×0.11 24,00,000×0.11

amount @ (9+3)=12% =3,60,000 =2,40,000 =1,20,000

a) Commitment fee on 6,00,000×0.01 6,00,000×0.01

unused portion@1% =10,000 =20,000
0

a) =C+D 3,60,000 2,50,000 1,40,000

a) EIR