Principles of Managerial Finance

(Dana P.) #1
CHAPTER 15 Current Liabilities Management 661

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$750,000. The cost of funds for the combined firms is 11%. What annual
savings, if any, are realized by this change of pay period?

15–8 Cost of bank loan Data Back-Up Systems has obtained a $10,000, 90-day
bank loan at an annual interest rate of 15%, payable at maturity. (Note:Assume
a 360-day year.)
a. How much interest (in dollars) will the firm pay on the 90-day loan?
b. Find the effective 90-day rate on the loan.
c. Annualize your result in part bto find the effective annual rate for this loan,
assuming that it is rolled over every 90 days throughout the year under the
same terms and circumstances.

15–9 Effective annual rate A financial institution made a $10,000, 1-year discount
loan at 10% interest, requiring a compensating balance equal to 20% of the face
value of the loan. Determine the effective annual rate associated with this loan.

15–10 Compensating balances and effective annual rates Lincoln Industries has a line
of credit at Bank Two that requires it to pay 11% interest on its borrowing and
to maintain a compensating balance equal to 15% of the amount borrowed. The
firm has borrowed $800,000 during the year under the agreement. Calculate the
effective annual rate on the firm’s borrowing in each of the following circum-
stances:
a. The firm normally maintains no deposit balances at Bank Two.
b. The firm normally maintains $70,000 in deposit balances at Bank Two.
c. The firm normally maintains $150,000 in deposit balances at Bank Two.
d. Compare, contrast, and discuss your findings in parts a, b,and c.

15–11 Compensating balance vs. discount loan Weathers Catering Supply, Inc., needs
to borrow $150,000 for 6 months. State Bank has offered to lend the funds at a
9% annual rate subject to a 10% compensating balance. Frost Finance Co. has
offered to lend the funds at a 9% annual rate with discount-loan terms. The
principal of both loans would be payable at maturity as a single sum.
a. Calculate the effective annual rate of interest on each loan.
b. What could Weathers do that would reduce the effective annual rate on the
State Bank loan?

15–12 Integrative—Comparison of loan terms Cumberland Furniture wishes to estab-
lish a prearranged borrowing agreement with its local commercial bank. The
bank’s terms for a line of credit are 3.30% over the prime rate, and each year the
borrowing must be reduced to zero for a 30-day period. For an equivalent
revolving credit agreement, the rate is 2.80% over prime with a commitment fee
of 0.50% on the average unused balance. With both loans, the required compen-
sating balance is equal to 20% of the amount borrowed. The prime rate is cur-
rently 8%. Both agreements have $4 million borrowing limits. The firm expects
on average to borrow $2 million during the year no matter which loan agreement
it decides to use.
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