Decision to Charge Appropriate Interest Rate - Essay Example

However, if any of the above mentioned determinants, fails to meet the expectations of the investors, then investors become shaky regarding their investments. The investors are mainly of two types, one who receives the ownership of the business by purchasing the shares of the company, in this way they invest in the company and are known as shareholders. They demand their return in two major ways i.e. dividends (distribution of profits) and capital gain (increase in the value of shares). On the other hand, the other kind of investors, are the creditors and they provide loans to the business such that amount of loan is repayable in certain time against which they demand a return in the form of interest.

Generally, if the financial prospects of the business seem sound in the future, shareholders also require more return. However, if the financial prospects of the company are to show more vulnerability and inconsistency, then loan providers charge higher interest because their investment comes at stake due to increasing risk of solvency, bankruptcy and likelihood of inability of business to pay interest and principal. In short, out of the two types of investors, i.e. shareholders and debt holders, this particular article mainly focuses upon the required rate of return demanded by the debt holders only.

Generally if an organization’s future financial outlook seems to be stable and bright looking, the debt holders prefer that organization to invest in as they would find their investment less risky as compared to that organization which is found to be struggling in dealing with its financial prospects. To be more specific, debt holders will charge less interest to that business which has consistent and growing cash flows, profitability, less amount of debt included in the overall capital structure and increasing net worth of the business.

All of the above mentioned factors are the determinants of a safe, prosperous and better looking business. Conversely, debt holders would charge a relatively higher interest from those businesses which have inconsistent cash flows and profitability, highly indebted and having vulnerable net worth of the business in upcoming periods. Debt holders find their investment highly risky and as a result of bearing that extra risk, they demand higher interest to compensate that risk. As far as ACME Consulting Business is concerned, its cash balance is going to increase at double rate on yearly basis with the amounts of $39K, $138K and $177K.

The net profit margin is also estimated to increase as it will be 0.33%, 4.87% and 5.94% respectively. Total Debt to Total Asset ratio will also be expected to decline from 76.55% to 61.24% in three years time. Lastly, Net Worth to Total assets of the business is estimated to increase from 65.09% to 86.31% in the same period. Debt ratio of the business is however higher than industry which is a questioning sign for the business. Net Worth ratio is better than the industry which can be a positive sign for the business in future.

For Interstate Travel Center, the cash balance will also be increased at almost a double pace, with