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Example of Loan Capital
Suppose that XYZ Manufacturing Inc. , a fictitious manufacturing business, wishes to grow by constructing a new factory. The estimated cost of this expansion is $5 million. Because it doesn’t have enough cash on hand for this project, XYZ Manufacturing chooses to borrow the money.
XYZ Manufacturing approaches Bank A and works out a full loan agreement. The loan is for a term of ten years with an annual interest rate of six percent. By accepting these terms, XYZ Manufacturing agrees to pay back the principal and interest on a regular basis over the next ten years.
Assuming that the loan is set up for full amortization over the course of ten years, XYZ Manufacturing will have paid back the entire $5 million principle by the end of that time. According to an amortization calculator, the business will pay $671,437 in loan payments each year.
Heres how it works:
- XYZ Manufacturing pays a total of $671,437 in the first year. 30% of this amount ($301,437 dollars) is interest (6% of $5 million), with the remaining $307,437 going toward principal reduction. This leaves a balance of $4,628,563 ($5 million – $371,437).
- XYZ Manufacturing once more pays a total of $671,437 in the second year. Nevertheless, the interest portion is currently only around $277,714% (6% of $4,628,563), and the $393,723 remaining goes toward decreasing the principal. This leaves a balance of $4,234,840.
- Until the loan is entirely repaid, this process is repeated every ten years, with the principal amount gradually rising and the interest portion gradually falling.
It should be noted that in reality, the business may also be required to pay loan origination fees and may incur penalties for late or prepayment of the loan. The loan agreement would contain all of these details.
This illustration shows how a business can use loan capital to fund significant initiatives. But XYZ Manufacturing would also have to weigh the cost and risk of borrowing money, including how interest costs would affect its net income and how it would require consistent cash flow to make loan payments.
FAQ
What is the meaning of loan capital?
The term “loan capital” describes the money that a business borrows and plans to pay back later, usually with interest. It’s a crucial source of funding for companies, particularly those that require funds for expansion, operations, or asset acquisition.
What is described as loan capital?
Loan capital is the cash obtained from outside sources, such as financial institutions, debentures, etc., that is required to run a business. It is a favorable funding option because it only consists of long-term funds that the business may use to conduct operations in exchange for interest or other fees.
What is the meaning of borrowing capital?
Money borrowed from others—individuals or banks—for the purpose of making an investment is known as borrowed capital. Unlike borrowed capital, equity capital is owned by the company and its shareholders.
What is included in loan capital?
Loan capital is defined as funding that has to be paid back. This type of funding consists of bonds, preferred stock, and loans that investors must repay.
Read More :
https://www.superfastcpa.com/what-is-loan-capital/
https://www.accountingtools.com/articles/loan-capital