In order to finance a shipment of badminton sets, Rujisawa Import-Export is seek

Question

In order to finance a shipment of badminton sets, Rujisawa Import-Export is seeking a $700,000 one-year bank loan. The Marine Bank requires that Rujisawa maintain a 25% compensating balance and requires four quarterly payments. The Lincoln Bank requires only a 15% compensating balance, but requires 12 monthly payments. In addition, Lincoln discounts the loan. Both banks state that their interest rate is 8%.

a) Which bank has the lowest effective interest rate? (NOTE: deduct the compensating balances from the principal in determining the effective rate) Please explain

b) If Lincoln Bank eliminated its compensating-balance requirement, would your answer change? Please explain.

Explanation / Answer

Marine Bank:Loan 700,000

25% COmp Bal = 25%*700000

So Effective Loan amt = 700000*(1-25%) =$525,000

Int for 1Yr @8% = 700,000*8%= 56000

So Int is 56000 on 525,000

So Int Rate = 56000/525000 = 10.67%

Effective Int Rate = (1+i/4)^4-1

= (1+10.67%/4)^4-1 = 11.10%

Lincoln Bank: 15% COmp Bal = 15%*700000

So Effective Loan amt = 700000*(1-15%) =$595,000

Int for 1Yr @8% = 700,000*8%= 56000

So Int is 56000 on 595,000

So Int Rate = 56000/595000 = 9.41%

It has 12 payments in 1 yr.

Effective Int Rate = (1+i/n)^n-1

= (1+9.41%/12)^12-1 = 9.83%

So Lincoln bank is cheaper.

(b) If Lincoln bank has no comp bal reqt,

It has 12 payments in 1 yr.

Effective Int Rate = (1+i/n)^n-1

= (1+8%/12)^12-1 = 8.30%

So Ans will not change

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