the cash available before optional debt repayments – is impacted by operating metrics such as revenue and EBITDA, as well as financing line items like mandatory amortization. In reality, the free cash flow (FCF) amount – i.e. The first step is to list out the model assumptions for our simple cash sweep exercise.įor purposes of simplicity, the “Excess Cash Available for Cash Sweep” line item is assumed to be $40m in all periods. We’ll now move to a modeling exercise, which you can access by filling out the form below. the risk of finding another borrower), which offsets the interest expense savings of the borrower, As a result, bonds and riskier debt securities lower in the capital structure are costlier forms of debt financing. Prepayment Fee: By charging a prepayment penalty, the lender is protecting the yield on their debt and receiving compensation for reinvestment risk (i.e.The terms of the arrangement surrounding prepayments is outlined in the formal lending agreement between the borrower and the lender (e.g. Prepayment Restrictions: Lenders set different minimum return hurdles based on their risk tolerance among other various factors, so their willingness to permit cash sweeps and the associated fee structures tends to be very specific to each particular situation.Thus, the borrower must weigh the pros and cons of using excess cash to pay down debt early, as the benefits of lower interest expense and reduced credit risk must outweigh any prepayment penalties incurred. the tax savings caused by interest expense lowering taxable income). Interest Tax Shield: One drawback, however, is that the reduced interest expense means the “tax shield” benefit of debt financing is also reduced (i.e.Financial Stability + Debt Capacity: Early payment improves the company’s financial stability, as well as its ability to secure debt financing on a later date when cash is running low (or refinancing in a lower-interest-rate environment).contributing to a lower debt-to-equity (D/E) ratio. Credit Profile: One of the key incentives for a company to opt for a cash sweep, other than lowering its interest expense burden, is to positively impact its credit profile – i.e. the amount of cash required to be on hand by the company to fund working capital needs) must also be taken into consideration. If the borrower has remaining excess cash, the borrower can periodically pay down debt early – assuming the credit agreement does not contain language prohibiting such prepayments.Īdditionally, the minimum cash balance of the company (i.e.
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