Assignment- Loan Scenarios

# Assignment- Loan Scenarios - a Which loan carries the lower...

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a. Which loan carries the lower effective rate? Consider fees to be the equivalent of other interest . Option 1 Here, Amount of loan = \$500,000 Compensating balance = \$500,000*20% = \$100,000 Therefore, Amount available to company = Amount of loan - compensating balance = 500000 – 100000 = 400000 Also, Interest = \$500,000*8.25% = \$41,250 Thus, Effective interest = Interest/Available funds = \$41,250/\$400,000 = 10.31% Option 2 Interest = \$500,000* 9.75% = \$48,750 Cost of borrowing = Interest + Fees = \$48,750 + \$5,500 = \$54,250 Therefore, Effective interest = Cost of borrowing/Loan amount = \$54,250/\$500,000 = 10.85% The loan with the compensating requirement has the lower effective cost (10.31% vs 10.850%). b. If the loan with a 20 percent compensating balance requirement were to be paid off in 12 monthly payments, what would the effective rate be? (Principal equals amount borrowed minus the compensating balance.) Effective rate on installment loan =(2*Annual no of payments*Interest)/[(Total no. of payments+1)*Principal]

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## This note was uploaded on 05/07/2010 for the course ACCOUNTING ACC225 taught by Professor Professor during the Spring '10 term at University of Phoenix.

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Assignment- Loan Scenarios - a Which loan carries the lower...

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