Cost of compensating balance:
Suppose a firm has a $100,000 line of credit with 10% compensating balance requirement Quoted interest on credit line = 16 % Firm needs $54,000 to purchase inventory.
1.) How much does a firm actually need to borrow? (Answer is 60,000 but I need to know how to get it so please show work)
2.) What is the effective interest rate? (The answer is 17.8% but I do not know how to get it so please show work)
A credit line is a flexible borrowing arrangement, typically between a company and a bank, that allows the company to borrow funds whenever needed and repay them whenever convenient. The arrangement is similar to a credit card for an individual.
Answer and Explanation:
The bank will keep 10% of the amount borrowed as a compensating balance. So:
- Amount needed = Amount borrowed * (1 - Compensating balance)
See full answer below.
Become a member and unlock all Study Answers
Try it risk-free for 30 daysTry it risk-free
Ask a question
Our experts can answer your tough homework and study questions.Ask a question Ask a question
Learn more about this topic:
from Financial Accounting: Help and ReviewChapter 5 / Lesson 30