Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 08: Sources of Short-Term Financing
13. Compensating balances (LO2) Computer Graphics Company needs $250,000 in funds for
a project.
a. With a compensating balance requirement of 20 percent, how much will the firm
need to borrow?
b. Given your answer to part a and a stated interest rate of 10 percent on the total
amount borrowed, what is the effective rate on the $250,000 actually being used?
8-13. Solution:
Computer Graphics Company
a.
( )
( )
Amount needed
Amount to be borrowed = 1C
$250,000 $250,000
1 .20 .80
$312,500
−
==
−
=
b.
$312,500 total amount borrowed
10% Interest rate
$ 31,250 Interest
$31,250 12.5% Effective rate
$250,000 =
14. Compensating balances and installment loans (LO2) The Dade Company is borrowing
$300,000 for one year and paying $27,000 in interest to Miami National Bank. The bank
requires a 20 percent compensating balance. What is the effective rate of interest? What
would be the effective rate if the company were required to make 12 monthly payments to
retire the loan? The principal, as used in Formula 8–6, refers to funds the firm can
effectively utilize (Amount borrowed – Compensating balance).
8-14. Solution:
Chapter 08: Sources of Short-Term Financing
The Dade Company
Effective rate of interest with 20% compensating balance =
Interest Days in the year(360)
Principal Compensating balance Days loan is outstanding
$27,000 360 $27,000 1 11.25%
$300,000 $60,000 360 $240,000
−
= = =
−
Installment loan with compensating balance
( )
2 Annual no. payments Interest
Total no. of payments +1 Principal
2 12 $27,000
(12 1) ($300,000 $60,000)
=
=+ −
$648,000 $648,000 20.77%
13 $240,000 $3,120,000
= = =
15. Compensating balances with idle cash balances (LO2) Randall Corporation plans to
borrow $200,000 for one year at 12 percent from the Waco State Bank. There is a 20
percent compensating balance requirement. Randall Corporation keeps minimum
transaction balances of $10,000 in the normal course of business. This idle cash counts
toward meeting the compensating balance requirement. What is the effective rate of
Chapter 08: Sources of Short-Term Financing
8-13
8-15. Solution:
Randall Corporation
Effective rate of interest =
Interest Days in the year(360)
Principal Compensating balance Days loan is outstanding
$24,000 360 $24,000 14.12%
$200,000 $30,000* 360 $170,000
−
=
−
( )
* $40,000 $10,000 $30,000−=
Required Compensating Balance − minimum balance on
deposit = additional funds needed at bank
16. Compensating balances with idle cash balances (LO2) The treasurer for the Macon Blue
Sox baseball team is seeking a $20,000 loan for one year from the 4th National Bank of
Macon. The stated interest rate is 10 percent, and there is a 15 percent compensating
balance requirement. The treasurer always keeps a minimum of $1,500 in the baseball
team's checking accounts. These funds count toward meeting any compensating balance
requirements. What will be the effective rate of interest on this loan?
8-16. Solution:
Macon Blue Sox Baseball Team
Effective rate of interest =
Interest Days in the year(360)
Principal Compensating balance Days loan is outstanding
$2,000 360 $2,000 10.81%
$20,000 $1,500* 360 $18,500
−
=
−
( )
* $3,000 $1,500 $1,500−=
Chapter 08: Sources of Short-Term Financing
8-14
17. Effective rate under different terms (LO2) Your company plans to borrow $5 million for
12 months, and your banker gives you a stated rate of 14 percent 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 14 percent interest with a 10 percent compensating balance.
b. Discounted interest.
c. An installment loan (12 payments).
d. Discounted interest with a 5 percent compensating balance.
8-17. Solution:
a. Simple interest with a 10% compensating balance
$700,000 $700,000
1 15.56%
$5,000,000 $500,000 $4,500,000
= =
−
b. Discounted interest
$700,000 $700,000
1 16.28%
$5,000,000 $700,000 $4,300,000
= =
−
c. An installment loan with 12 payments
2 12 $700,000 $16,800,000 25.85%
13 $5,000,000 $65,000,000
==
d. Discounted interest with a 5% compensating balance
( )
$700,000 / $5,000,000 – $700,000 – $250,000
$700,000/$4,050,000 = 17.28%
=
Chapter 08: Sources of Short-Term Financing
8-15
18. Effective rate under different terms (LO2) If you borrow $4,000 at $500 interest for one
year, what is your effective interest rate for the following payment plans?
a. Annual payment.
b. Semiannual payments.
c. Quarterly payments.
d. Monthly payments.
8-18. Solution:
Use formula 8-6 for b, c, and d.
Rate on installment loan =
( )
2 Annual no. of payments Interest
Total no. of payments + 1 Principal
19. Effective rate under different terms (LO2) Zerox Copying Company plans to borrow
$150,000. New Jersey National Bank will lend the money at one-half percentage point over
the prime rate at the time of 8 1/2 percent (9 percent total) and requires a compensating
balance of 20 percent. The principal in this case will be funds that the firm can effectively
use in the business. This loan is for one year. What is the effective rate of interest? What
would the effective rate be if Zerox were required to make four quarterly payments to retire
the loan?
8-19. Solution:
Chapter 08: Sources of Short-Term Financing
8-16
Zerox Copying Company
Effective rates of interest with compensating balance
First determine interest
Then determine the rate
$13,500 $13,500
1 11.25%
$150,000 30,000 $120,000
= =
−
Effective rate of interest with compensating balance and 4
quarterly payments.
2 4 $13,500 $108,000 18%
(4 1) $120,000 $600,000
==
+
20. Installment loan for multiyears (LO2) Lewis and Clark Camping Supplies Inc. is
borrowing $45,000 from Western State Bank. The total interest is $12,000. The loan will
be paid by making equal monthly payments for the next three years. What is the effective
rate of interest on this installment loan?
8-20. Solution:
Lewis and Clark Camping Supplies
Rate on installment loan =
( )
( )
2 Annual no. of payments Interest
Total no. of payments + 1 Principal
2 12 $12,000 $288,000 17.30%
36 1 $45,000 $1,665,000
= = =
+
Chapter 08: Sources of Short-Term Financing
21. Cash discount under special circumstance (LO2) Mr. Hugh Warner is a very cautious
businessman. His supplier offers trade credit terms of 3/10, net 80. Mr. Warner never takes the
discount offered, but he pays his suppliers in 70 days rather than the 80 days allowed so he is
sure the payments are never late. What is Mr. Warner's cost of not taking the cash discount?
8-21. Solution:
Hugh Warner
Discount % 360
Cost of not taking =
a cash discount 100% Disc.% Final duedate
Discount period
3% 360
100% 3% (70 10)
3.09% 6 18.54%
−−
=
−−
= =
In this problem, Mr. Warner has the use of funds for 60 extra
22. Bank loan to take cash discount (LO1 & 2) The Reynolds Corporation buys from its
suppliers on terms of 2/10, net 55. Reynolds has not been utilizing the discounts offered
and has been taking 55 days to pay its bills.
Mr. Duke, Reynolds Corporation vice president, has suggested that the company begin to
take the discounts offered. Duke proposes that the company borrow from its bank at a
stated rate of 14 percent. The bank requires a 20 percent compensating balance on these
loans. Current account balances would not be available to meet any of this compensating
balance requirement.
Do you agree with Duke's proposal?
8-22. Solution:
Chapter 08: Sources of Short-Term Financing
8-18
Reynolds Corporation
Discount % 360
Cost of not taking a cash =
discount 100% Disc.% Final due date
Discount period
2% 360 2.04% 8 16.32%
98% (55 10)
−−
= = =
−
Effective rate of interest with a 20% compensating balance
requirement:
23. Bank loan to take cash discount (LO1 & 2) In Problem 22, if the compensating balance
requirement were 10 percent instead of 20 percent, would you change your answer? Do the
appropriate calculation.
8-23. Solution:
Reynolds Corporation (Continued)
Effective rate of interest with a 10% compensating balance
requirement:
( ) ( ) ( )
Interest rate 14% 14% 15.56%
1 C 1 .1 .9
= = = =
−−
Chapter 08: Sources of Short-Term Financing
24. Bank loan to take cash discount (LO1 & 2) Neveready Flashlights, Inc., needs $300,000
to take a cash discount of 2/10, net 70. A banker will loan the money for 60 days at an
interest cost of $5,500.
a. What is the effective rate on the bank loan?
b. How much would it cost (in percentage terms) if the firm did not take the cash
discount, but paid the bill in 70 days instead of 10 days?
c. Should the firm borrow the money to take the discount?
d. If the banker requires a 20 percent compensating balance, how much must the firm
borrow to end up with the $300,000?
e. What would be the effective interest rate in part d if the interest charge for 60 days
were $6,850? Should the firm borrow with the 20 percent compensating balance?
(The firm has no funds to count against the compensating balance requirement.)
8-24. Solution:
Neveready Flashlights, Inc.
a.
$5,500 360
Effective rate of interest = $300,000 60
1.83% 6 10.98%
= =
b.
( )
2% 360
Cost of lost discount = 98% 70 10
2.04% 6 12.24%
−
= =
d.
( ) ( )
Amount
$300,000 $300,000 $300,000 $375,000 needed to be
1 C 1 .20 .80 borrowed
===
−−
