(Estimating the cost of bank credit) Paymaster Enterprises has arranged to finan
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Question
(Estimating the cost of bank credit) Paymaster Enterprises has arranged to finance its seasonal working-capital needs with a short-term bank loan. The loan will carry a rate of 12 percent per annum with interest paid in advance (discounted). In addition, Paymaster must maintain a minimum demand deposit with the bank of 11 percent of the loan balance throughout the term of the loan. If Paymaster plans to borrow $120,000 for a period of 3 months, what is the effective cost of the bank loan? Hint: Assume the Paymaster does not have sufficient funds in the bank to satisfy the compensating balance requirement. The effective cost, or APR, of the bank loan is? % (Round to two decimal places.)Explanation / Answer
Interest for 3 months:
= $120,000×12%×3/12
= $3,600
APR:
= [$3,600/($120,000×(1-11%)-$3,600)]×12/3
= ($3,600/$103,200)×4
= 13.95%
Hence, APR is 13.95%
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