# Effective rate / EPS

1. John Fleming has been shopping for a loan to finance the purchase of a used car. He has found three possibilities that seem attractive and wishes to select the one with the lowest interest rate. The information available with respect to each of the three $5,000 loans is shown in the following table:

Loans Principal Annual Payment Term (years)

A $5,000 $1,352.81 5

B $5,000 $1,543.21 4

C $5,000 $2,010.45 3

a. Determine the interest rate associated with each of the loans

b. Which loan should John take?

2. Southland Industries has $60,000 of 16% (annual interest) bonds outstanding, 1,500 shares of preferred stock paying an annual dividend of $5 per share, and 4,000 shares of common stock outstanding. Assuming that the firm has a 40% tax rate, compute earnings per share (EPS) for the following levels of EBIT:

a. $24,600

b. $30,600

c. $35,000

3. Weathers Catering Supply, Inc. needs to borrow $150,000 for 6 months. State Bank has offered to lend the funds at a 9% annual rate subject to a 10% compensating balance. (Note: Weathers currently maintains $0 on deposit in State Bank). Frost Finance Co. has offered to lend the funds at a 9% annual rate with discount-loan terms. The principal of both loans would be payable at maturity as a single sum.

a. Calculate the effective annual rate of interest on each loan.

b. What could Weathers do that would reduce the effective annual rate on the State Bank loan?

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#### Solution Summary

The solution explains how to calculate the effective rate of interest and EPS given the EBIT