![]() ![]() 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. Cash Flow from Financing in the Current Period.Cash Flow from Investing in the Current Period.Cash Flow from Operations in the Current Period.“Rolled-Over” Excess Cash on the B/S from the Prior Period.The excess cash is the amount remaining once all the following have been accounted for: In Excel, the formula for the cash sweep must calculate the free cash flow once all required payments are met, including the mandatory amortization of debt. Modeling the Cash Sweep: LBO Debt Paydown Such lenders may also charge substantial prepayment penalties, even should early prepayment be allowed. In contrast, other returns-oriented lenders will typically issue debt with provisions prohibiting early prepayment, either for a specified period or for the entire duration of the loan. corporate banks), who prioritize capital preservation above all else, will gladly accept early payment with either minimal (or no) early prepayment penalties imposed on the borrower. the periodic payments to the lender in exchange for the borrowing) to decline.Ĭertain debt providers such as senior lenders (e.g. The reduction in debt principal also causes the interest expense (i.e. The discretionary, early pay-down of debt reduces the principal balance coming due on the date of maturity – which decreases the credit risk of the borrower. Once all mandatory payments have been met, a borrower can opt to pay down a portion of its outstanding debt earlier than anticipated with its excess cash (if any).Ĭash Sweep: Financial Model Debt Schedule The Cash Sweep refers to the optional prepayment of debt using excess free cash flows in advance of the originally scheduled repayment date. ![]()
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