(Estimating the cost of bank credit) Paymaster Enterprises has arranged to finan
ID: 2765101 • Letter: #
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 16 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 $90,000 for a period of four months, what is the effective cost of the bank loan? Assume paymaster does not have sufficient funds in the bank to satisfy the compensating balance requirement.
The effective cost or APR of the bank loan is?
______% ROUND 2 DECIMAL PLACES
Explanation / Answer
The effective cost of the loan will be a minimum balance of 10% of the borrowing of $ 90,000 = $ 9,000 plus 16% of the amount of $ 90,000 which becomes an effective anual rate of 17.22% amounting to $ 15,498.
The total interest is $ 24,498 which works out to 27.22% as the effective cost or APR of the loan.
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