Agriculture Reference
In-Depth Information
The installment loan results in the highest APR since the full amount of the loan is available
for only one month. At the end of the fi rst month, part of the principal is repaid to the
lender.
Other restrictions
Lenders often place restrictions on the management prerogatives of an agribusiness during
the loan period. These restrictions vary from requiring monthly and annual fi nancial state-
ments or other fi nancial information regarding inventories, accounts receivable, and accounts
payable to actual restrictions on expending capital funds without the approval of the lender.
Often banks require that fi rms maintain certain ratios during the loan period, such as a cur-
rent ratio not below 2.0. Agribusiness managers must be sure that they can live comfortably
with these restrictions before they agree to them. Otherwise, they may fi nd themselves
severely handicapped in decision-making and in their fl exibility to meet changing conditions
and capitalize on new opportunities.
Interest rates and taxes
One of the things that agribusiness managers often overlook is that they can deduct from the
business's taxable income every dollar of interest paid, because the interest is a business
expense. To know the effective cost of borrowing funds, the manager must know the after-
tax cost of interest. This effect can best be seen by looking at net income after taxes, before
and after borrowing.
For example, assume Doug Davies's company (a corporation) borrowed the $100,000 at
8 percent interest; the following tabular information is used to illustrate the impact of interest
paid on the after-tax cost of borrowing:
Before loan
After loan
Net operating income
$50,000
$50,000
Interest charges
- 0
-$8,000
Net income before taxes
$50,000
$42,000
Income tax (assume 25% rate)
-$12,500
-$10,500
Net income after taxes
$37,500
$31,500
The difference between the two situations is $6,000. The effective interest rate for decision-
making purposes is then only 6 percent. The formula is:
(
)
After-tax Cost
=
Before-Tax cost
×
1
.0
−
Marginal Tax Rate
(
)
=
Afte
r-tax Cost
=×−
8
%.
l
00
.
25
6
%
In this example, the fi rm paid $8,000 in interest on the original $100,000 loan. However,
since these interest payments are tax deductible business expenses, the IRS really subsidizes
the interest payments. The amount of the subsidy is equal to the fi rm's marginal tax rate, in
this case 25 percent. So the fi rm paid “out of pocket interest costs” of $6,000.
