Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia would prefer the flexibility of floating rate borrowing, while Paraguas wants the security of fixed rate borrowing. Lluvia is the more creditworthy company. They face the following rate structure.
Lluvia, with the better credit rating, has lower borrowing costs in both types of borrowing. Lluvia wants floating rate debt, so it could borrow at LIBOR + 1%. However, it could borrow fixed at 8% and swap for floating rate debt. Paraguas wants fixed rate debt, so it could borrow fixed at 12%. However, it could borrow floating at LIBOR + 2% and swap for fixed rate debt. What should they do? Get Finance homework help today