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Chapter 3: 16BP (page 250)

The treasurer for the Macon Blue Sox baseball team is seeking a \(23,600 loan for one year from the 4th National Bank of Macon. The stated interest rate is 10 percent, and there is a 15 percent compensating balance requirement. The treasurer always keeps a minimum of \)2,280 in the baseball team’s checking accounts. These funds count toward meeting any compensating balance requirements. What will be the effective rate of interest on this loan?

Short Answer

Expert verified

The effective interest rate is 10.56%.

Step by step solution

01

Information provided in the question

Loan amount = $23,600

Loan term = 1 year

Interest rate = 10%

Compensating balance = 15%

Minimum transaction balance = $2,280

02

Calculation of interest payable

The interest payable is $2,360.

Interestpayable=Interest×Principal=10%×$23,600=$2,360

03

Calculation of compensating balance in monetary terms

The compensating balance is $3,540.

Compensatingbalance=Compensatingbalancerate×Principal=15%×$23,600=$3,540

04

Calculation of additional funds needed by the bank

The additional funds needed by the bank is $1,260.

Additionalfundsneeded=Requiredcompensatingbalance-Minimumtransactionbalance=$3,540-$2,280=$1,260

05

Calculation of effective interest rate on loan

The effective interest rate with a 15% compensating rate is 10.56%.

Effectiverate=InterestPrincipal-Compensatingbalance×DaysinyearDaysloanisoutstanding=$2,360$23,600-$1,260×360360=10.56%

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Most popular questions from this chapter

What are three theories for describing the shape of the term structure of interest rates (the yield curve)? Briefly describe each theory.

In the second year, Fisk Corporation finds that it can reduce ordering costs to \(2 per order but that carrying costs stay the same at \)1.60 per unit. Also, volume remains at 49,000 units per year.

d. What is the total cost of ordering and carrying inventory?

Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. Do an analysis similar to that in the right-hand portion of Table 6-6.

1-year T bill at the beginning of year 1

5%

1-year T bill at the beginning of year 2

8%

1-year T bill at the beginning of year 3

7%

1-year T bill at the beginning of year 4

10%

Neon Light Company of Kansas City ships lamps and lighting appliances throughout the country. Ms. Neon has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by three days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Florida.

b. If Neon Light Company can earn 6 percent per annum on freed-up funds, how much will the income be?

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms?
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