5 Mr. Pardeep owns a business of toys. At present he sells his product in North and West India, but now planning to sell his products in South India also. For this he applied to the bank for enhancement of his overdraft limit from ₹50 Lakhs to ₹75 Lakhs. Bank manager suggested him to take 'Term Loan' of ₹25 Lakh instead of increasing overdraft limit. Do you think he should consider Term Loan instead of overdraft limit? Give reasons. (3 marksSee answer

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5 Mr Pardeep owns a business of toys At present he sells his product in North and West India but now planning to sell his products in South India also For this he applied to the bank for enhancement…

Question

5 Mr. Pardeep owns a business of toys. At present he sells his product in North and West India, but now planning to sell his products in South India also. For this he applied to the bank for enhancement of his overdraft limit from ₹50 Lakhs to ₹75 Lakhs. Bank manager suggested him to take ‘Term Loan’ of ₹25 Lakh instead of increasing overdraft limit. Do you think he should consider Term Loan instead of overdraft limit? Give reasons. (3 marks

Basic Answer

Core Answer:

Yes, Mr. Pardeep should consider a term loan instead of increasing his overdraft limit.

Reasons and Explanations:

Reason 1: Purpose-Specific Funding: A term loan is specifically designed for long-term investments like business expansion (entering the South Indian market). Overdrafts are meant for short-term, fluctuating capital needs. Expanding into a new region is a capital expenditure requiring a longer repayment period, aligning better with a term loan’s structure.

Reason 2: Lower Interest Costs (Potentially): While interest rates vary, term loans often come with fixed interest rates for the loan tenure. Overdrafts usually have fluctuating interest rates based on market conditions, potentially leading to higher overall interest costs over the long term. A fixed rate provides predictability in financial planning for Mr. Pardeep.

Reason 3: Improved Financial Planning: A term loan provides a structured repayment schedule, allowing for better budgeting and cash flow management. Overdrafts offer flexibility but can lead to unpredictable repayments if not managed carefully, potentially impacting his business’s financial stability during expansion.

Summary:

Considering the nature of Mr. Pardeep’s business expansion into South India, a term loan offers better financial planning, potentially lower interest costs, and aligns more appropriately with the long-term nature of the investment compared to simply increasing his overdraft limit.