A firm agrees to accept annual payments on a $1,000,000 loan with a fixed interest rate of 8% in exchange for making the annual payments on a loan with floating rate payments based on LIBOR.Payments are interest only with principal due in 10 years.If LIBOR falls to 7%,the firm's net cash flow will be:

Question

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The firm pays 8% interest on the $1,000,000 loan, which is $80,000 annually. If LIBOR falls to 7%, the firm receives $70,000 from the floating rate loan. The net cash flow is $70,000 (received) - $80,000 (paid) = -$10,000. However, the question asks for the net cash flow, which is the absolute value of the difference, $10,000.

A Firm Agrees to Accept Annual Payments on a $1,000,000