Nancy Lopez, Treasurer of National Mortuary Supply, has asked for your help in s

Question

Nancy Lopez, Treasurer of National Mortuary Supply, has asked for your help in sourcing a one-year, $500,000 working capital loan. She has obtained the following loan proposals from various banks and thrifts: The Third Federal Bank of Boston offers a simple interest loan at a stated annual interest rate of 14.97%. However, the bonk requires a 6% compensating balance, and National Mortuary Supply does not have an account with this bank. Delaware Savings Bank is offering a discount interest loan at a stated annual interest rate of 2.5% over Delaware Savings prime, which Ms. Lopez determined to be 3 percent over the New York Prime Rate of 9%. The First Western Bank and Trust Company offered an installment loan at a stated annual interest rate of 7.95%. Interest is computed on the add-on basis. Homeland Federal Savings offered a discount interest loan at a stated annual interest rate of 13% with a 5% compensating balance requirement. However, National Mortuary Supply maintains a savings account in this institution with an average balance of $6,250.00 The loan officer with the Third Federal Bank of Boston later called Ms. Lopez with what he described as a better offer to gain her business. He offered her a discount interest loan at a stated 13.20% interest rate with only a 4% compensating balance. Based upon the information given, what should Ms. Lopez do? Remember that she needs use of the full $500,000. HINT: This question requires you to evaluate option and make a recommendation. A full credit answer will properly analyze all of the options, present the best option, indicate why it was selected as the best option, and indicate any and all of the actions that would be required to accept the best option.

Explanation / Answer

For a one-year $500,000 working capital loan, a) Simple Interest loan 14.97% requiring 6% balance The compensating balance parts makes this calculation more difficult than a "Simple Interest" loan. (500,000 +y) - (500,000 + y)0.06 = 500,000 y = $ 31, 915 APR = Interest paid/ money received $531, 915 signed for $611, 543 must be paid back. APR = $ 79, 628/ $ 531, 915 = 0.15 If you transfer the account balance from Homeland Federal Savings, (500,000 + 6250 + y)- (500,000 +y)0.06 = 500,000 the loan required decreases to $525,266 APR = $78,632/ $ 525, 266 = 0.15 the same APR with $603,898 to pay back. b) Discount Interest loan If the interest rate is 14.5%, which is 2.5% over 3% over 9% y = $ 84,795 Signed for amount $ 584, 795 APR = 84,795/ $500,000 = 0.17, slightly higher than d), but no balance is required. c) Installment loan at 7.95% APR = $79,500 / $500,000 = 0.16 The actual amount loaned would be significantly higher, $1,079,500, as roughly half the amount of installment loans is available on average over one year. d) Discount interest loan, 13% with 5% compensating balance Amount received is 13% less than amount signed for. I'm assuming that the 5% compensating balance is on $ signed for. (500,000 + 6250 + y) - (500,0000 + y)0.18 = 500,000 y= $ 102,134 Signed for amount $602,134 APR = $78,277/$ 523, 857 = 0.15 with combined $30, 107 in the bank Here's a conversion formula for discount to simple interest: i = d/(1-dt) , where d is the discount interest, t is time in years. i = 0.13/(1-0.13 (1))= 0.149, a 14.9% simple interest loan would be equivalent. Notice the same is offered in part a) above, but a higher balance is required in a). e) Discount interest loan, 13.20% with 4% compensating balance Amount received is 13.2% less than amount signed for. Same calculation as d) minus the $6250 (500,000 + y) - (500,000 + y)0.172 = 500,000 Amount signed for $ 603, 865, with $ 24,155 in the bank APR = $79,710/ $524, 155 = 0.15 No advantage over d). The argument for Delaware Savings is that no minimum balance is required and no transfer of balance from Homeland Federal would be required. The amount borrowed would be approximately $20,000 less than Homeland Federal's offer. The APR is very close. Are there any other hidden fees or penalties? Expect to read the full contract before signing anything. Overall, this option looks the best on paper, but I would compare everything before making a decision. Other questions: How financially healthy is Delaware Savings vs. Homeland Federal? The argument for Homeland Federal: APR of 0.15 is slightly less than APR of 0.17. Homeland Federal is the current bank for National Mortuary Supply. I did not compare the 9% discount interest loan at New York Prime as it was not one of the options. If it were a choice, it would be the best one at 0.09 APR, no required balance, and significantly less interest to repay. Very, very confusing to me. I'm happy I'm not a loan officer, and I don't need a loan!

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