Question

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P16-12 Compensating balances and effective annual rates Lincoln Industries has a line of credit at Bank Two that requires it to pay 11% interest on its borrowing and to maintain a compensating balance equal to 15% of the amount borrowed. The firm has borrowed $800,000 during the year under the agreement. Calculate the effective annual rate on the firm's borrowing in each of the following circumstances: a. The firm normally maintains no deposit balances at Bank Two. b. The firm normally maintains $70,000 in deposit balances at Bank Two. c. The firm normally maintains $150,000 in deposit balances at Bank Two. d. Compare, contrast, and discuss your findings in parts a, b, and c.

Answer 1

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VD 4x = 03:35 ENG 18-03-202024 EN137 2 135 136 - X V fx ELEMEN EO EP EQ ER E S 137 138 LINCOLN NO COMPENSATING BALANCE IS MAINTAINED BORROWED INTEREST RATE COMPENSATING BALANCE 800000 11% 120000 [800000 X 15%] USABLE LOAN BALANCE = INTEREST ON LOAN 680000 [800000 - 120000] 88000.00 [800000 X 11%] EAR = 12.94% [88000/680000] 151 COMPENSATING BALANCE OF 70000 IS MAINTAINED BORROWED 800000 INTEREST RATE 11% COMPENSATING BALANCE REQUIRED 50000 [120000 - 70000 MAINTAINED] 153 USABLE LOAN BALANCE = INTEREST ON LOAN 750000 88000.00 157 158 EAR = 11.73% [88000/750000] BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE ... cash opti LINE OF CREDIT Sheet5 eoq miller CARD Sheet3 Sheet4

VD 4x = 03:35 ENG 18-03-202024 - X EL fx EM EN EO EP EQ ER E S EM173 2 159 160 161 162 163 COMPENSATING BALANCE OF 150000 IS MAINTAINED BORROWED 800000 INTEREST RATE 11% COMPENSATING BALANCE REQUIRED O [AS 150000 IS MAINTAINED] 165 USABLE LOAN BALANCE = INTEREST ON LOAN 800000 88000.00 167 EAR = 11.00% [88000/800000] 168 169 170 d 171 OPTION :C HAS LEAST COST AS FULL COMPENSATING BALANCE IS MAINTAINED 172 173 177 181 182 ... cash opti LINE OF CREDIT Sheet5 eoq miller CARD BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE Sheet3 Sheet4