Your firm is considering the following three alternative bank loans for $1,000,0

Question

Your firm is considering the following three alternative bank loans for $1,000,000:

a) 10% loan paid at year end with no compensating balance
b) 9% loan paid at year end with a 20% compensating balance
c) 6% loan that is discounted with a 20% compensating balance requirement

Assume that you would normally not carry any bank balance that would meet the 20% compensating balance requirement. What is the rate of annual interest on each loan?

Explanation / Answer

a) 10% b) Nominal interest/proceeds = 90,000/(1,000,000-200,000-90,000) = 90,000/710,000 = 0.1268 -> 12.68% c) 60,000/(1,000,000-200,000-60,000) = 60,000/740,000 = 0.0845 -> 8.45%

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