Chapter 08: Sources of Short-Term Financing
Zerox Copying Company
Effective rates of interest with compensating balance
(4 1) $135,880 $679,400
+
20. Installment loan for multiyears (LO2) Lewis and Clark Camping Supplies Inc. is
borrowing $51,000 from Western State Bank. The total interest is $15,700. 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 $15,700 $376,800 19.97%
36 1 $51,000 $1,887,000
= = =
+
Chapter 08: Sources of Short-Term Financing
Reynolds Corporation
Discount % 360
Cost of not taking a cash =
discount 100% Disc.% Final due date
Discount period
3% 360 3.09% 12.86 39.74%
97% (45 17)
−−
= = =
−
Effective rate of interest with a 27 percent compensating balance
requirement:
= Interest rate/(1 – C)
= 16%/(1 – .27)
= 16%/(.73) = 21.92%
The effective cost of the loan, 21.92 percent, is less than the cost
of passing up the discount, 39.74 percent. Reynolds Corporation
should borrow funds from the bank and pay the invoice early in
order to take advantage of the discount.
23. Bank loan to take cash discount (LO1 and 2) The Reynolds Corporation buys from its
suppliers on terms of 3/17, net 45. Reynolds has not been utilizing the discounts offered
and has been taking 45 days to pay its bills.
Mr. Duke, Vice President of Reynolds Corporation, 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 16 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?
8-23. Solution:
Reynolds Corporation
Chapter 08: Sources of Short-Term Financing
Discount % 360
Cost of not taking a cash =
discount 100% Disc.% Final due date
Discount period
3% 360 3.09% 12.86 39.74%
97% (45 17)
−−
= = =
−
Effective rate of interest with a 20 percent compensating balance
requirement:
( ) ( ) ( )
Interest rate 16% 16% 20.00%
1 C 1 .20 .8
= = = =
−−
The answer now changes. The effective cost of the loan, 20.00
percent, is less than the cost of passing up the discount, 39.74
percent. Reynolds Corporation should borrow the funds and pay
early to take the discount.
