Week 7 - Loan Scenarios


Midland Chemical Co. is negotiating a loan from Manhattan Bank and Trust.

The small chemical company will need to borrow
$775,000
.


The bank offers the following:


Interest Rate
8.50%

Compensating balance requirement
15%


or as an alternative…


Interest Rate
12.00%

Additional bank fees
$4,600


In either case the rate on the loan is floating (changes as the prime

rate changes), and the loan would be for one year.


a. Which loan carries the lower effective rate? Consider fees to be the

equivalent of other interest.


b. If the loan with the 20% compensating balance were to be paid off

In 12 monthly payments, what would the effective rate be?

(Principal equals amount borrowed minus compensating balance.)


c. Because the interest rate on the loans is floating, it can go up as

interest rates go up. Assume that the prime rate goes up by 2%

and the quoted rate on the loan goes up by the same amount.

What would then be the effective rate on the loan with

compensating balances? Convert the interest rate to dollars

as the first step in your calculation.

Optional Information:
Country/State/Province of question: sc

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