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Chapter 3: 26BP_c (page 252)

Summit Record Company is negotiating with two banks for a \(151,000 loan. Fidelity Bank requires a 28 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a 14 percent compensating balance, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 10 percent. Compensating balances will be subtracted from the \)151,000 in determining the available funds in part a.

c. Does your choice of banks change if the assumption in part b is correct?

Short Answer

Expert verified

The decision does not change as the effective interest rate offered by Southwest bank is low in both parts a and b.

Step by step solution

01

Calculation of effective interest rate on the loan taken from Fidelity bank

The effective interest rate is 31.83%.

Effectiveinterestrate=2脳Annualnumberofpayments脳InterestrateTotalnumberofpayments+1脳Principal-Interestpayable=2脳4脳$15,1004+1脳$151,000-$15,100=$120,800$379,500=31.83%

02

Calculation of effective interest rate on the loan taken from Southwest bank

The effective interest rate is 18.46%.

Effectiveinterestrate=2脳Annualnumberofpayments脳InterestrateTotalnumberofpayments+1脳Principal=2脳12脳$15,10012+1脳$151,000=$362,400$1,963,000=18.46%

03

Decision regarding the bank from which the loan should be taken

Fidelity bank offers the loan at an effective interest rate of 31.83% whereas Southwest bank has an effective interest rate of 18.46%. The company should borrow funds from Southwest bank.

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Most popular questions from this chapter

Assume that Atlas Sporting Goods Inc. has \(840,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 15 percent, but with a high-liquidity plan the return will be 12 percent. If the firm goes with a short-term financing plan, the financing costs on the \)840,000 will be 9 percent, and with a long-term financing plan, the financing costs on the $840,000 will be 11 percent. (Review Table 6-11 for parts a, b, and c of this problem.)

a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.

d. If the firm used the most aggressive asset financing mix described in part a and had the anticipated return you computed for part a, what would earnings per share be if the tax rate on the anticipated return was 30 percent and there were 20,000 shares outstanding?

e. Now assume the most conservative asset financing mix described in part b will be utilized. The tax rate will be 30 percent. Also assume there will only be 5,000 shares outstanding. What will earnings per share be? Would it be higher or lower than the earnings per share computed for the most aggressive plan computed in part d?

Simmons Corp. can borrow from its bank at 17 percent to take a cash discount. The terms of the cash discount are 1.5/10, net 45. Should the firm borrow the funds?

Guardian Inc. is trying to develop an asset financing plan. The firm has \(400,000 in temporary current assets and \)300,000 in permanent current assets. Guardian also has $500,000 in fixed assets. Assume a tax rate of 40 percent.

c. What would happen if the short- and long-term rates were reversed?

Talmud Book Company borrows $24,900 for 60 days at 12 percent interest. What is the dollar cost of the loan?

Dollar cost of loan = Amount borrowed X Interest rate X Days loan is outstanding/ Days in a year (360)

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