Question

nitiduri APK 18-8A/(Cost of short-term bank loan) The Southwest Forging Corporation recently arranged for a line of credit with the First National Bank of Dallas. The terms of the agreement called for a $100,000 maximum loan with interest set at 1 percent over prime. In addition, the firm has to maintain a 20 percent compensating balance in its demand deposit account throughout the year. The prime rate is currently 12 percent. V a. If Southwest normally maintains a $20,000 to $30,000 balance in its checking account with FNB of Dallas, what is the effective cost of credit through the line-of-credit agree- ment where the maximum loan amount is used for a full year? b. Re-compute the effective cost of credit to Southwest if the firm will have to borrow the compensating balance and it borrows the maximum possible under the loan agreement. Again, assume the full amount of the loan is outstanding for a whole year. (18-9A, (Cost of commercial paper) Tri-State Enterprises plans to issue commercial paper for the first time in the firm's 35-year history. The firm plans to issue $500,000 in 180-day maturity notes. The paper will carry a 10-1/4 percent rate with discounted interest and will cost Tri-State $12,000 (paid in advance) to issue. a. What is the cost of credit to Tri-State? b. What other factors should the company consider in analyzing the use of commercial paper?

Answer 1

Note: Only the first question is answered as HOMEWORKLIB guidelines.

(a): The effective cost of credit in scenario (a) with adequate amount in checking account= 13%

(b) The effective cost in scenario (b) with compensating balance part of borrowing=16.25%

Details of computation as below: