Carter Enterprises and Brence Manufacturing can each issue floating or fixed rate debt. Carter issues floating rate debt at LIBOR + 2% and considers swapping payments with Brence, who issues fixed rate debt at 11%. Under the swap, Carter would pay Brence 7.95% fixed and receive LIBOR, resulting in a net rate of -9.95% after swap. This is better than Carter's 10% fixed rate option. For Brence, the swap results in a net rate of LIBOR + 3.05% which is better than its floating rate option of LIBOR + 3.1%. The swap benefits both companies.

1. Carter Enterprises can issue floating-rate debt at LIBOR + 2% or fixed-rate debt
at 10%. Brence Manufacturing can issue floating-rate debt at LIBOR + 3.1% or
fixed-rate debt at 11%. Suppose Carter issues floating-rate debt and Brence
issues fixed-rate debt. They are considering a swap in which Carter makes a
fixed-rate payment of 7.95% to Brence and Brence makes a payment of LIBOR to
Carter.
After Carter issues floating rate debt and then swaps, its net cash flows is:
-(LIBOR + 2%) ¨C 7.95% + LIBOR = -9.95%. This is less than the 10% rate at which
it could directly issue fixed rate debt, so the swap is better for Carter.
For Brence, issueing fixed rate debt and then swaping, its net cash flows is:
-11% + 7.95% - LIBOR = -(LIBOR + 3.05%). This is less than the rate at which it
could directly issue floating rate debt (LIBOR + 3.1%), so the swap is better
for Brence.