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Chapter 3: 17BP_a (page 251)

Your company plans to borrow $13 million for 12 months, and your banker gives you a stated rate of 24 per cent interest. You would like to know the effective rate of interest for the following types of loans. (Each of the following parts stands alone.)

a. Simple 24 per cent interest with a 10 percent compensating balance.

Short Answer

Expert verified

The effective interest rate is 26.67%.

Step by step solution

01

Information provided in the question

Loan amount = $13,000,000

Loan term = 1 year

Interest rate = 24%

Compensating balance = 10%

02

Calculation of interest payable

The interest payable is $3,120,000.

Interestpayable=Interest×Principal=24%×$13,000,000=$3,120,000

03

Calculation of compensating balance in monetary terms

The compensating balance is $1,300,000.

Compensatingbalance=Comepnsatingbalancerate×Principal=10%×$13,000,000=$1,300,000

04

Calculation of effective interest rate on loan

The effective interest rate with a 10% compensating rate is 26.67%.

Effectiverate=InterestPrincipal-Compensatingbalance×DaysinyearDaysloanisoutstanding=$3,120,000$13,000,000-$1,300,000×360360=26.67%

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Most popular questions from this chapter

Postal Express has outlets throughout the world. It also keeps funds for transactions purposes in many foreign countries. Assume in 2010 it held 240,000 reals in Brazil worth 170,000 dollars. It drew 12 percent interest, but the Brazilian real declined 24 percent against the dollar.

a. What is the value of its holdings, based on U.S. dollars, at year-end? (Hint: Multiply $170,000 times 1.12 and then multiply the resulting value by 76 percent.)

Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 7 percent. Lear’s earnings before interest and taxes are \)240,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 30 percent.

b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $240,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

c. What are some of the risks and cost considerations associated with each of these alternative financing strategies?

What is an asset-backed public offering?

Bombs Away Video Games Corporation has forecasted the following monthly sales:

January

\(100,000

February

\)93,000

March

\(25,000

April

\)25,000

May

\(20,000

June

\)35,000

July

\(45,000

August

\)45,000

September

\(55,000

October

\)85,000

November

\(105,000

December

\)123,000

Total annual sales

\(756,000

Bombs Away Video Games sells the popular Strafe and Capture video game. It sells for \)5 per unit and costs \(2 per unit to produce. A level production policy is followed. Each month’s production is equal to annual sales (in units) divided by 12.

Of each month’s sales, 30 percent are for cash and 70 percent are on account. All accounts receivable are collected in the month after the sale is made.

b. Prepare a monthly schedule of cash receipts. Sales in the December before the planning year are \)100,000. Work part b using dollars.

How is a cash budget used to help manage current assets?
See all solutions

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