Manage debt with a swap Building a toll road or bridge can improve the lives of commuters and be a boon to many kinds of business; however, it can also raise an interesting financial puzzle. Toll roads or large bridges cost hundreds of millions of dollars to build, and may not be fully used until years after construction. Quite often, the revenue generated from such projects isn’t sufficient to meet the operating cash flow requirements in the initial years of operation. Thus, the dilemma: how can a company afford to pay its operating costs and service its debt when it’s not expected to generate its maximum potential revenue until far into the future? One solution is a swap — a type of derivative that exchanges one series of cash flows for another. Cash swap In general, a cash swap meets the long-term cash requirements of a toll bridge, toll road or other similar business by providing sufficient capital for initial construction and operating cash flow requirements. In subsequent years, as the cash requirements for operations remain steady or decline and revenues increase, the swap is repaid. Companies could also use a cash swap to fund a long-term contract that generates cash flow in a way that differs from the cost of fulfilling the contract. Interest-rate swap In a different scenario, imagine a company that has a steady revenue stream, but has a loan arrangement that requires debt payments at a variable interest rate. With a variable rate, the company faces uncertainty as to how much cash is needed to meet its debt obligation. Working with a financial institution, the company could create an interest-rate swap, which would allow it to exchange a variable interest rate for a fixed rate. For example, the bank could assume the monthly debt payments based on a variable interest rate, while charging interest to the company at a fixed rate. This would allow the company to make fixed payments for the life of the debt. In essence, the company has converted its variable-interest rate debt into a fixed-interest rate debt for a fee. Both the cash swap and the interest-rate swap are sophisticated debt instruments that meet specific needs. If your company is considering using a derivative to manage debt, speak with a professional advisor. Bhupender Gosain is an Assurance & Advisory Principal with the Public Company Team. He can be reached at (416) 644-4409 or by e-mail at bhupender_gosain@mintzca.com. Mintz & Partners | 1 Concorde Gate, Suite 200, North York, Ont., M3C 4G4 | www.mintzca.com Phone: (416) 391-2900 | Fax: (416) 391-2748 | E-mail: info@mintzca.com The Statement is an e-newsletter written by the Public Company Team of Mintz & Partners LLP. Please go to http://www.mintzca.com/index.php?section=pcdirectory to learn more about our Public Company Team The issues raised are for information purposes only. Readers are urged to contact their professional advisors before acting on the basis of the material contained herein. |