Section B 20 (a) Your company has a line ofcredit through a local bank. The bank

Question

Section B 20 (a) Your company has a line ofcredit through a local bank. The bank requires a 6% compensating balance and charges 12% on the amount borrowed against the line. If the comp calculate the effective annual rate on the loan. You've worked out a line of credit arrangement that allows you to borrow up to $100 million at any time. The interest rate is 0.4 percent per month. In addition, 5% of the amount that you borrow must be deposited in a non-interest bearing account (i.e. a compensating balance). Assume that your bank uses compound interest on its line of credit loans. What is the effective annual rate (EAR) on the loan? What is the APR on the loan? Which rate would the bank advertise- the any needs $100,000 to purchase inventory, find the amount it should borrow,and (b) APR or the EAR? 21. Use the following financial statement information: Item Inventory Beginning $1,500 2.,300 Ending $1.800 2.600 1.100

Explanation / Answer

20. a) You require $100,000 after the 6% compensating balance, so you need to borrow a bit more than $100,000 so that after keeping the 6% balance at the bank, you would get $100,000 for your need. We have -

Amount required + Compensating Balance = Amount borrowed

If amount borrowed is 100 and compensating balance 6% of this, i.e., 6, then Amount required is 94 or 94% of the amount borrowed. So, we have -

Amount borrowed = $100,000 / 94% = $106,382.978723

The interest would be paid on the amount borrowed, however since you are getting only $100000, the effective rate would be computed on $100000 -

Interest to be paid = 12% x $106,382.978723 = $12,765.9574467

Effective rate = ($12,765.9574467 / $100,000) x 100 = 12.765957446% or 12.77%

b) Similar to above, first compute the monthly interest you would be paying on the actual borrowing amount.

Interest to be paid on whole amount of borrowing = $100 million x 0.4% = $400,000

Amount actually received = $100 million - 5% of $100 million = $95 million

Effective monthly rate = ($400,000 / $95,000,000) x 100 = 0.421052631%

Now, Effective annual rate (EAR) is computed as follows -

EAR = (1 + r / m)m

where, r = Annual rate, m = no. of times compounded in a year = 12

We have already calculated r / m = 0.421052631%

EAR = (1 + 0.00421052631)12 - 1 = 0.05171297762 or 5.17%

ARP = 0.4 x 12 = 4.8%

The bank would advertise the APR as it less than the EAR, so that it can attract more customers toward its loan product.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

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