Ch15

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: l be 10% (9% 1%), but when the prime rate changes, so will the rate of interest on the note. For instance, if after 30 days the prime rate rises to 9.5%, and after another 30 days it drops to 9.25%, the firm will be paying 0.833% for the first 30 days (10% 30/360), 0.875% for the next 30 days (10.5% 30/360), and 0.854% for the last 30 days (10.25% 30/360). Its total interest cost will be $2,562 [$100,000 (0.833% 0.875% 0.854%)], resulting in an effective 90-day rate of 2.562% ($2,562/$100,000). Again, assuming the loan is rolled over each 90 days throughout the year under the same terms and circumstances, its effective annual rate is 10.65%: Effective annual rate (1 0.02562)4 1 1.1065 1 0.1065 10.65% Clearly, in this case the floating-rate loan would have been less expensive than the fixed-rate loan because of its generally lower effective annual rate. Lines of Credit line of credit An agreement between a commercial bank and a business specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time. A line of credit is an agreement between a commercial bank and a business specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time. It is similar to the agreement under which issuers of bank credit cards, such as MasterCard, Visa, and Discover, extend preapproved credit to cardholders. A line-of-credit agreement is typically made for a period of 1 year and often places certain constraints on the borrower. It is not a guaranteed loan but indicates that if the bank has sufficient funds available, it will allow the borrower to owe it up to a certain amount of money. The amount of a line of credit is the maximum amount the firm can owe the bank at any point in time. When applying for a line of credit, the borrower may be required to submit such documents as its cash budget, its pro forma income statement, its pro forma balance sheet, and its recent financial stat...
View Full Document

This document was uploaded on 01/19/2014.

Ask a homework question - tutors are online