Week 7 Assignment - Loan Scenarios

Week 7 Assignment - Loan Scenarios - Midland Chemical Co....

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Midland Chemical Co. is negotiating a loan from Manhattan Bank and Trust. The small chemical company needs to borrow $500,000. The bank offers a rate of 8¼ percent with a 20 percent compensating balance requirement, or as an alternative, 9¾ percent with additional fees of $5,500 to cover services the bank is providing. In either case the rate on the loan is floating (changes as the prime interest rate changes), and the loan would be for one year. a. Which loan carries the lower effective rate? Consider fees to be the equivalent of other interest. Compensating Balance Loan 500,000 1-.20 =500,000 .80 = 625,000 amount to be borrowed 8.25% 1-.20 =8.25% .80 =10.3125% Effective Rate Fee Added Loan 500,000 x 9.75% = 48,750 interest 48,750+5,500 = 54,250 500,000 = 500,000 =10.85% Effective Rate The loan with the compensating balance has the lower effective rate. 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
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Week 7 Assignment - Loan Scenarios - Midland Chemical Co....

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