Suppose your firm is seeking a six-year, amortizing $700,000 loan with annual payments and your bank...

Suppose your firm is seeking a six-year, amortizing $700,000 loan with annual payments and your bank is offering you the choice between a $740,000 loan with a $40,000 compensating balance and a $700,000 loan without a compensating balance. The interest rate on the $700,000 loan is 9.0 percent.

How low would the interest rate on the loan with the compensating balance have to be for you to choose it?(Do not round intermediate calculations and round your final answer to 2 decimal places.)

Interest Rate % __________

Expert Solution

Step-1: Calculate the annual payments on loan without a compensating balance:

Present Value of Loan (PV) = 700,000

Interest Rate (i) = 9%

Period of loan (n) = 6

Using excel PMT function (rate = 9%, nper = 6, pv = 700,000)

Annual Payment = $156,043.85

Step-2: Now calculate the interest rate that for loan amount 207,000 and period 6 year result PMT = 156,043.85

Using RATE function in excel (nper = 6, pmt = -156,043.85, pv = 740,000)

Interest Rate is 7.17%

Ans: 7.17%

jeff jeffy answered 2 years ago

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