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Homework answers / question archive / Develop a gap financing scenario involving a permanent floor-celing loan
Develop a gap financing scenario involving a permanent floor-celing loan. Specific numbers or percentages should be assumed for such variables as construction cost, construction loan amount, mortgage loan amount (ceiling and floor), and rent roll requirement. The scenario should show how the gap financing can ensure that the entrepreneur avoids the problem of cash shortgage during the construction period.
Tutorial Guide: Several theoritical definitions of GAP Financing are available on the internet today. So, I have chose not to give any theoritical answer, rather the concept of GAP is discussed through a practical case scenario which is discussed in multiple parts.
Answer to the given question:
In order to develop a Gap Financing scenario; first we need to understand what is Gap Financing.
However, without writing a bookish definition of GAP Financing let us go through the following example (data provided in 3 parts) to understand the entire process of GAP Financing:-
1. Say, ABC Ltd. is a Construction Company who wants to build a commercial building worth $500,000
2. However, they have to incur following expenses to build that building:
- Material Cost worth $200,000
- Labour Cost worth $100,000
- Fees of Civil Engineers $50,000
- Painting and other desinging expenses $50,000
Hence, Total Cost of the project would be = $(200,000+100,000+50,000+50,000) = $400,000
3. Now say, in order to arrange that project cost ABC Ltd. went to a commercial Bank. In market scenario, in case of construction loans most of the commercial banks lends only 70% of the expected sales price. So, in the present case also bank agrees to lend $350,000 @ 6% p.a. , which is 70% of the expected turnover of $500,000.
Explanation: In the given case, ABC Ltd. required $400,000 to finance their project.
However, the commercial bank agreed to lend only upto $350,000
Hence, money to be required by ABC Ltd further would be $50,000 [$400,000 - $ 350,000]
This $50,000 is popularly Gap in Finance.
Again, the $350,000 bank agreed to lend, would be called floor ceiling loan.
Now, ABC Ltd has following alternatives to fund the GAP of $50,000 which arising out in the above scenario-
1. Entity may arrange the money by their own, i.e., from fund generated internally due past assignments.
2. Take a bridge loan from family, friends or related lenders.
3. Entity may issue some shares through private placement.
4. Enity may go for some Right issue of shares.
5. Entity may ask for trade credit facilities from their suppliers for material worth $50,000.
6. Bank overdraft facilities can be availed upto $50,000
7. Or, any other means whichever suitable for the firm.
