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Topic
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A company obtained a short-term bank loan of $500,000 at an annual interest rate of eight percent. As a condition of the loan,
the company is required to maintain a compensating balance of $100,000 in its checking account. The checking account earns
interest at an annual rate of three percent. Ordinarily, the company maintains a balance of $50,000 in its account for
transaction purposes. What is the effect interest rate of the loan?
a. 7.77 percent.
b. 8. 50 percent.
c. 9.44 percent.
d. 8.56 percent.
Becker answer is : Choice “d” is correct. 8.56%. To calculate the effect annualized percentage cost of financing:
Step 1 Calculate the actual finance charge:
Actual interest = (P x Rate x Time)
$500,000 X 8% = $40,000
Step 2 Subtract any interest earned (if any) on additional required compensating balance:
Additional interest earned: $50,000 x .03 = $1,500
Net interest cost= $40,000 [from Step 1] – $1,500 = $38,500
Step 3 Divide the difference (net interest) by the loan proceeds the company has use of:
Loan proceeds company has use of: $500,000- $50,000 (additional balance)= $450,000
I get the big picture, but my question is why they dont use $100,000 but $50,000? Any ideas please, thanks in advance
AUD 81
FAR 76
BEC 5/31/13
REG 07/13
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