The Boyles Ceramics, Inc. established a line of credit with a local bank. The ma

Question

The Boyles Ceramics, Inc. established a line of credit with a local bank. The maximum amount that can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent. A compensating balance averaging 25 percent of the amount borrowed is required. Prior to the agreement, Boyles had no deposit with the bank. Shortly after signing the agreement, Boyles needed $240,000 to pay off a note that was due. Boyles decides to borrow an amount sufficient to pay the $240,000 note and also to cover the compensating balance. How much must Boyles Glass borrow?

Explanation / Answer

Compensating balance is the minimum balance to be kept with the bank used to offset the cost incurred by the bank.

Here requirement is 25% of the amount borrowed.

The Boyles Ceramics, Inc needs 240,000$ . But he do not have any amount in bank account means he will have to borrow amount of compensating balance too

Hence total amount to be borrowed = 240,000/0.75 = 320,000$

Thus against borrowed amount of 320,000$ , (320,000*25%) 80,000$ will be kept as compensating balance and rest 240,000$ can be used

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