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Chapter 3: 25BP_e (page 252)

Harper Engine Company needs \(631,000 to take a cash discount of 2.5/20, net 75. A banker will lend the money for 55 days at an interest cost of \)13,300.

e. What would be the effective interest rate in part d if the interest charge for 55 days were $10,100? Should Harper borrow with the 10 percent compensating balance? (There are no funds to count against the compensating balance requirement.)

Short Answer

Expert verified

The effective interest rate is 11.66% so the firm should borrow the funds.

Step by step solution

01

Information available

Loan amount = $631,000

Loan term = 55 days

Interest = $10,100

Compensating balance = 10%

Cost of not taking discount = 16.77%

02

Calculation of compensating balance in monetary terms

The compensating balance is $63,100

Compensatingbalance=Compensatingbalancerate脳Principal=10%脳$631,000=$63,100

03

Calculation of cost of effective interest rate

The effective interest rate is 11.66%.

Effectiveinterestrate=InterestPrincipal-Compensatingbalance脳DaysinayearDaysoutstandingintheloan=$10,100$631,000-$63,100脳36055=11.66%

04

Decision on whether to borrow the money or not

The effective interest rate is 11.66% and the cost of not taking the discount is 16.77%, so the firm should borrow funds for taking the cash discount.

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