Cost of compensating balance: Suppose a firm has a $100,000 line of credit with 10% compensating...

Question:

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)

Credit Line:

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:

1)

The bank will keep 10% of the amount borrowed as a compensating balance. So:

  • Amount needed = Amount borrowed * (1 - Compensating balance)
  • 54,000...

See full answer below.

Become a Study.com member to unlock this answer! Create your account

View this answer

Learn more about this topic:

Loading...
How to Calculate the Rate of Return: Definition, Formula & Example

from Financial Accounting: Help and Review

Chapter 5 / Lesson 30
515K

Related to this Question

Explore our homework questions and answers library