I need the correct answers for a, b, and c. Thank You A bank offers your firm a

Question

I need the correct answers for a, b, and c. Thank You

A bank offers your firm a revolving crédit arrangement for up to $69 million at an interest rate of 1 40 percent per quarter. The bank also requires you to maintain a compensating balance of 5 percent against tne unused portion of the crédit line, to be deposited in a noninferest-bearing account Assume you have a short-term investment account at the bank that pays 81 percent per quarter. and assume that the bank uses compound interest on its revolving credit loans What is your effective annual interest rate (an opportunity cost) on the revolving credit arrangement if your firm does not use it during the year? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

a. If the Firm does not use the Credit arrangement than the opportunity cost will be:

Unused Portion = $69 million

Compensating Balance = 69 x 5% = $3.45 Million

Loss of Interest of .81% Per Quarter

Total Interest Loss = .81 x 4 = 3.24%

Effective Annual Rate = (1 + r / m)m - 1

r = Interest Rate = 3.24%, m = Compounding Frequency = 4,

Effective Annual Rate = (1 + 3.24% / 4)4 - 1

Effective Annual Rate = 3.2796%

b) If Firm borrow $46 million, than interest will be charged at the rate of 1.40% Per Quarter

Annual Interest = 1.40 x 4 = 5.60%

Than Effective Annual Rate will be calculated:

Effective Annual Rate = (1 + r / m)m - 1

r = Interest Rate = 5.60%, m = Compounding Frequency Per Year = 4

Effective Annual Rate = (1 + 5.60% / 4)4 - 1

Effective Annual Rate = 5.7187%

Unused Portion = 69 - 46 = $23 Million

Compensating Balance = 23 x 5% = $1.15 million

Calculation of Weighted Average Effective Annual Rate:

Total of Borrowing and Deposite = 46 + 1.15 = $47.15 million

Proportion of Borrowing = 46 / 47.15 = 97.56%

Proportion of Deposite = 1.15 / 47.15 = 2.44%

Weighted Average Effective Annual Rate = (EAR of Borrowing x Proportion of Borrowing) + (EAR of Deposite x Proportion of Deposite)

Weighted Average EAR = (5.7187 x 0.9756) + (3.2796 x 0.0244)

EAR = 5.56%

c) If total $69 million is Borrowed than the EAR = 5.72%

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