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75 5 some generally very large firms can borrow from

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Unformatted text preview: dle of 2002). Since 1995, it has fluctuated in the range from a high of about 9.50% to a low of about 4.75%. 5. Some, generally very large, firms can borrow from their banks at an interest rate slightly below the prime rate. This typically occurs when the borrowing firm either maintains high deposit balances at the bank over time or agrees to pay an upfront fee to “buy down” the interest rate. Below-prime-rate loans are clearly the exception rather than the rule. 6. Effective annual rates (EARs) for loans with maturities of less than 1 year can be found by using the technique presented in Chapter 4 for finding EARs when interest is compounded more frequently than annually. See Equation 4.23. CHAPTER 15 discount loans Loans on which interest is paid in advance by being deducted from the amount borrowed. Current Liabilities Management 643 When interest is paid in advance, it is deducted from the loan so that the borrower actually receives less money than is requested. Loans on which interest is paid in advance are called discount loans. The effective annual rate for a discount loan, assuming a 1-year period, is calculated as Interest Amount borrowed Interest (15.4) Paying interest in advance raises the effective annual rate above the stated annual rate. EXAMPLE Wooster Company, a manufacturer of athletic apparel, wants to borrow $10,000 at a stated annual rate of 10% interest for 1 year. If the interest on the loan is paid at maturity, the firm will pay $1,000 (0.10 $10,000) for the use of the $10,000 for the year. Substituting into Equation 15.3 reveals that the effective annual rate is therefore $1,000 $10,000 10.0% If the money is borrowed at the same stated annual rate for 1 year but interest is paid in advance, the firm still pays $1,000 in interest, but it receives only $9,000 ($10,000 $1,000). The effective annual rate in this case is $1,000 $10,000 $1,000 $1,000 $9,000 11.1% Paying interest in advance thus makes the effective annual rate (11.1%) greater than the stated annual rate (10.0%). Single-Payment Notes single-payment note A short-te...
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