Location via proxy:   [ UP ]  
[Report a bug]   [Manage cookies]                
Scribd
Upload
288 views

Problem 5 and 6

1) The document presents two loan options for Epoch Record Company from Trust Bank and Northeast Bank. 2) Without compensating balances, Northeast Bank has a lower effective interest rate of 18.46% compared to Trust Bank's 20.28%. 3) However, if Epoch normally maintains $20,000 deposits at each bank to serve as compensating balances, Trust Bank has a lower effective rate of 15.82% versus Northeast Bank's 16.62%. 4) In this case, the optimal choice of bank would change from Northeast Bank to Trust Bank.

Uploaded by

Lalaina Enriquez
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
288 views

Problem 5 and 6

1) The document presents two loan options for Epoch Record Company from Trust Bank and Northeast Bank. 2) Without compensating balances, Northeast Bank has a lower effective interest rate of 18.46% compared to Trust Bank's 20.28%. 3) However, if Epoch normally maintains $20,000 deposits at each bank to serve as compensating balances, Trust Bank has a lower effective rate of 15.82% versus Northeast Bank's 16.62%. 4) In this case, the optimal choice of bank would change from Northeast Bank to Trust Bank.

Uploaded by

Lalaina Enriquez
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 4

ACTIVITY 6: Chapter 14

Problem 5
Ready Flashlights,Inc. needs ₱ 300,000 to take a cash discount of 2/10, net 70. A banker will loan
the money for 60 days at an interest cost of ₱ 5,500.
Required:
a. What is the effective rate on the bank loan?

Effective rate of interest = ₱ 5,500 x 360


₱300,000 60
= 1.83% x 6
=10.98%

b. How much would it cost ( in percentage terms( if the firm did not take the cash discount, but
paid the bill in 70 days instead of 10 days?

Cost of lost discount = 2% x 360


98% (70-10)

=2.04 % x6

= 12.24%

c. Should the firm borrow the money to take the discount?


Yes, the firm must borrow money to get the discount in specific reason of that the cost of
borrowing is less than the cost of losing the discount.
d. If the banker requires a 20 percent compensating balance, how much must the firm borrow
to end up with the ₱ 300,000?

= ₱300,000 (1-C)
=₱300,000
(1-.20)
=₱300,000
.80
=₱375,000
The Amount needed to be borrowed is ₱375,000.

e. What would be the effective interest rate in part d if the interest charge for 60 days were
₱6,850? Should the firm borrow with the 20 percent compensating balance?(The firm has no
funds to count against the compensating balance requirement.)

Effective interest rate = ₱6,850 X 360


₱375,000 - ₱75,000 60

= ₱6,850 x6
₱300,000
=2.28% x 6
=16.8%
No, the firm must not borrow 20% compensating balance, because the effective rate is
greater than the savings from taking the cash discount.

Problem 6

Epoch Record Company is negotiating with two banks for a ₱100,000 loan.
Trust bank requires a 20 percent compensating balance, discounts the loan, and wants to be paid
back in four quarterly payments. Northeast Bank requires a 10 percent compensating balances,
does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for
both banks is 9 percent. Compensating balances will be subtracted from the ₱ 100,000 in
determining the available funds in part a.

Required:
a. Which loan should Epoch Accept?
Trust Bank:
2 x 4 x P 9.000
Effective Interest Rate =
( ₱ 100,000−₱ 20,000−₱ 9,000 ) x( 4+ 1)
₱ 72,000
= ₱ 355,000

= 20.28%
Northeast Bank:
2 x 12 x P 9.000
Effective Interest Rate =
( ₱ 100,000−₱ 10 , 000 ) x (12+1)
₱ 216,000
= ₱ 1,170,000

= 18.46%

Epoch Company should accept the loan from Northeast Bank, Because it has a lowest
effective rate between the two banks

b. Recompute the effective cost of interest, assuming that Epoch ordinarily maintains at each
bank ₱20,000 in deposits that will serve as compensating balances.

Trust Bank:
₱ 72,000
Effective Interest Rate =
( ₱ 100,000−₱ 9,000 ) x 5
₱ 72,000
= ₱ 455,000

= 15.82%
Northeast Bank:
₱ 216,000
Effective Interest Rate =
( ₱ 100,000 x 13 )
₱ 216,000
= ₱ 1,300,000

= 16.62%

c. Does your choice of banks change if the assumption in part b is correct?

Yes. My choice of bank would change if the assumption in part b is correct. Because,
when the compensating balance maintained for the both banks in the normal courses of epoch
company, then I think the trust bank should be the one to choose over Northeast bank. Thus, the
effective cost of it’s loan will be less.

You might also like