? Estimating the cost of bank? credit) Paymaster Enterprises has arranged to fin

Question

?

Estimating the cost of bank? credit) Paymaster Enterprises has arranged to finance its seasonal? working-capital needs with a? short-term bank loan. The loan will carry a rate of 14 percent per annum with interest paid in advance? (discounted). In? addition, Paymaster must maintain a minimum demand deposit with the bank of 10 percent of the loan balance throughout the term of the loan. If Paymaster plans to borrow $80,000 for a period of 4 ?months, what is the annualized cost of the bank? loan?

The annualized cost of the bank loan is

Explanation / Answer

Amount need to borrow = $80,000

The loan is issued at discount

Annual Rate = 14%

Interest Rate for 4 months = 4.67%

So, Total amount need to borrow = $80,000/(1 - 4.67%)

= $83,916.08

So, interest rate = ($83,916.08/$80,000) - 1

= 1.04895 - 1 = 4.895%

Also company has to maintain 10% compensating balance

So, effective six month interest rate = 4.895%/(1 - 10%)

= 5.44%

Effective Interest Rate for 4 months = 5.44%

Effective Annual Rate = [(1 + 5.44%)3] - 1

= 1.1722 - 1

= 17.22%

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