Question
In: Accounting
Problem 15-7 (similar to) (Cost of short-term financing) You plan to borrow $30 comma 000 from...
Problem 15-7 (similar to) (Cost of short-term financing) You plan to borrow $30 comma 000 from the bank to pay for inventories for a gift shop you have just opened. The bank offers to lend you the money at 11 percent annual interest for the 6 months the funds will be needed. a. Calculate the effective rate of interest on the loan. b. In addition, the bank requires you to maintain a compensating balance of 18 percent in the bank. Because you are just opening your business, you do not have a demand deposit account at the bank that can be used to meet the compensating-balance requirement. This means that you will have to put up 18 percent of the loan amount from your own personal money (which you had planned to use to help finance the business) in a checking account. What is the cost of the loan now? c. In addition to the compensating-balance requirement in part (b), you are told that interest will be discounted. What is the effective rate of interest on the loan now? a. What is the effective rate of interest, or APR, on the loan
Solutions
Expert Solution
| a | Effective rate of interest = Annual interest rate x (No. of months loan/12 months) | ||
| = 11% x 6/12 | |||
| = 5.5% | |||
| b | Loan amount | $30,000 | |
| Compensating balance (30000 x 18%) | $5,400 | ||
| Available Principle | $24,600 | ||
| Interest on loan (30000 x 5.5%) | $1,650 | ||
| Cost of the loan (1650/24600) | 6.71% | ||
| If interest will be discounted | |||
| Loan amount | $30,000 | ||
| Compensating balance (30000 x 18%) | $5,400 | ||
| Interest on loan (30000 x 5.5%) | $1,650 | ||
| Available Principle (30000-5400-1650) | $22,950 | ||
| Effective rate | 7.19% | ||
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