Your company needs to borrow $100,000 to purchase equipment. The equipment will

Question

Your company needs to borrow $100,000 to purchase equipment. The equipment will pay for itself in 1 year and the company is considering the following alternatives for financing its purchase:

Which alternative should your company choose? Please SHOW CALCULATIONS and answer the last bold questions.

Alternative A: The firm’s bank has agreed to lend $100,000 at a rate of 14%. Interest would be discounted, and a 15% compensating balance would be required. However, the compensating-balance requirement would not be binding on the company because the company normally maintains a minimum demand deposit (checking account) balance of $25,000 in the bank.

Alternative B: The equipment dealer has agreed to finance the equipment with a 1 year loan. The $100,000 loan would require payment of principal and interest totaling $116,300.

If the bank’s compensating-balance requirement were to necessitate idle demand deposits equal to 15% of the loan, what effect would this have on the cost of the bank loan alternative?

Comment

Explanation / Answer

14000/10000

=14%

Interest/Princpal

=14000/85000

=16.47%

Alternative A Loan Amount 100000 Rate of interest 14% Funding 100% Effective annual cost of credit Interst/Princpial

14000/10000

=14%

Alternative B Loan Amount 100000 Future amount would be paid 116300 Effective rate annally 16.30% if the compensating balance required @15% Loan Amount 100000 Compensating balance 15% Amount to be use only 85% Interest rate 14% Interest amount 14000 Principal amount 85% of 100000 85000 Effective rate annally

Interest/Princpal

=14000/85000

=16.47%

16.47%

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.