The Dixon Corporation has an outstanding 1-year bank loan of $300,000 at a stated interest rate of 8% In addition, Dixon is required to maintain a 20% compensating balance in its checking account. Assuming the company would normally maintain a zero balance in its checking account, the effective interest rate on the loan is
Answer(s): D
The requirement to maintain a compensating balance of 20% of the $300,000 loan means that the borrower has effective use of only 80% of the loan, or $240,000. The 8% interest rate applied to a $300,000 loan requires an annual interest expenditure of $24,000. In turn, paying $24,000 for the use of $240,000 indicates an effective interest rate of 10%.
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?
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%.
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)
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)
When a company offers credit terms of 3/10, net 30, the annual interest cost based on a 360-day year is
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).
With respect to the use of commercial paper by an industrial firm, which one of the following statements is most likely to be true?
Answer(s): B
Most commercial paper has a maturity of between 60 and 270 days.
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