QUESTION: 251 Topic 4: Part 2 Sec Four (204 to 257)

Elan Corporation is considering borrowing $100,000 from a bank for 1 year at a stated interest rate of 9%. What is the effective interest rate to Elan if this borrowing is in the form of a discounted note?

8.10%
9.00%
9.81%
9.89%

Answer(s): D

Explanation:

Applying the 9% interest rate to a $100,000 loan results in interest expense of $9,000. If the loan is processed in the form of a discounted note, the interest will be deducted from the proceeds of the loan. Thus, the $9,000 of interest will be deducted from the $100,000 note, resulting in loan proceeds of $91,000. The borrower is paying $9,000 for a loan of $91,000, resulting in an effective interest rate of 9.89%.

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QUESTION: 252 Topic 4: Part 2 Sec Four (204 to 257)

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The Flesher Corporation was recently quoted terms on a commercial bank loan of 6% discounted interest with a 22% compensating balance. The term of the loan is 1 year. The effective cost of borrowing is (rounded to the nearest hundredth)

6.00%
6.38%
7.69%
8.33%

Answer(s): D

Explanation:

Assuming a $1000 loan, the interest at 6% tor 1 year is $60. Hence, the proceeds of the loan with discounted (paid-in-advance) interest are $940 ($1,000 --$60). Also, 22% of the note, or $220, cannot be used by the borrower because of the compensating balance requirement. Consequently, only $720 is available for use. Paying $60 interest for the use of $720 results in an effective cost of borrowing of 8 33% ($60 - $720)

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QUESTION: 253 Topic 4: Part 2 Sec Four (204 to 257)

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When a company offers credit terms of 3/10, net 30, the annual interest cost based on a 360-day year is

36.7%
24.5%
37.1%
55.6%

Answer(s): D

Explanation:

Assume that the gross amount of an invoice is $1,000. Given a 3% discount, the buyer will pay $970 on the tenth day. Thus, the seller is forgoing $30 to receive payment 20 days sooner than would otherwise be required. The 20-day interest rate (rounded) is 3.09% ($30 ÷ $970). The number of 20-day periods in a year is 18(360 20). If the interest rate is 3.09% for each 20-day period, the annual interest rate (rounded) is 55.6% (18 x 3.09).

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