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Chapter 3: 16BP (page 250)

The treasurer for the Macon Blue Sox baseball team is seeking a \(23,600 loan for one year from the 4th National Bank of Macon. The stated interest rate is 10 percent, and there is a 15 percent compensating balance requirement. The treasurer always keeps a minimum of \)2,280 in the baseball team鈥檚 checking accounts. These funds count toward meeting any compensating balance requirements. What will be the effective rate of interest on this loan?

Short Answer

Expert verified

The effective interest rate is 10.56%.

Step by step solution

01

Information provided in the question

Loan amount = $23,600

Loan term = 1 year

Interest rate = 10%

Compensating balance = 15%

Minimum transaction balance = $2,280

02

Calculation of interest payable

The interest payable is $2,360.

Interestpayable=Interest脳Principal=10%脳$23,600=$2,360

03

Calculation of compensating balance in monetary terms

The compensating balance is $3,540.

Compensatingbalance=Compensatingbalancerate脳Principal=15%脳$23,600=$3,540

04

Calculation of additional funds needed by the bank

The additional funds needed by the bank is $1,260.

Additionalfundsneeded=Requiredcompensatingbalance-Minimumtransactionbalance=$3,540-$2,280=$1,260

05

Calculation of effective interest rate on loan

The effective interest rate with a 15% compensating rate is 10.56%.

Effectiverate=InterestPrincipal-Compensatingbalance脳DaysinyearDaysloanisoutstanding=$2,360$23,600-$1,260脳360360=10.56%

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Most popular questions from this chapter

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

c. Should Henderson liberalize credit if a 16 percent after-tax return on investment is required?

Why are Treasury bills a favorite place for financial managers to invest excess cash?

Barney鈥檚 Antique Shop has annual credit sales of \(1,620,000 and an accounts receivable balance of \)157,500. Calculate the average collection period (use 360 days in a year).

Fisk Corporation is trying to improve its inventory control system and has installed an online computer at its retail stores. Fisk anticipates sales of 49,000 units per year, an ordering cost of \(8 per order, and carrying costs of \)1.60 per unit.

b. How many orders will be placed during the year?

City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers so the firm鈥檚 checks will take longer to clear the bank. Collection time has been reduced by two days and disbursement time increased by one day because of these policies. Excess funds are being invested in short-term instruments yielding 12 percent per annum.

a. If City Farm has \(5 million per day in collections and \)3 million per day in disbursements, how many dollars has the cash management system freed up?
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