Summit Record Company is negotiating with two banks for a $134,000 loan. Fidelit

Question

Summit Record Company is negotiating with two banks for a $134,000 loan. Fidelity Bank requires a compensating balance of 18 percent, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a compensating balance of 9 percent, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 12 percent. Compensating balances will be subtracted from the $134,000 in determining the available funds in part a. a-1. Calculate the effective interest rate for Fidelity Bank and Southwest Bank. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Which loan should Summit accept? Southwest Bank Fidelity Bank Recomputed the effective cost of interest, assuming that Summit ordinarily maintains $24,120 at each bank in deposits that will serve as compensating balances. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Does your choice of banks change if the assumption in part b is correct? Yes No

Explanation / Answer

a-1)

Fidelity Bank =((1+ 12%/4)^4 -1)/(1-18%)

Fidelity Bank = 15.31%

Southwest Bank =((1+ 12%/12)^12 -1)/(1-9%)

Southwest Bank = 13.94%

b)

Percentage of Compensation Balance = 24120/134000 = 18%

Fidelity Bank =((1+ 12%/4)^4 -1)/(1-18%)

Fidelity Bank = 15.31%

Southwest Bank =((1+ 12%/12)^12 -1)/(1-18%)

Southwest Bank = 15.47%

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