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Effective interest rate

Mime Theatrical Supply is in the process of negotiating a line of credit with two local banks. The prime rate is currently 8 percent. The terms follow:
Bank Loan Terms
1st National
1 percent above prime rate on a discounted basis and a 20 percent compensating balance on the face value of the loan.

2nd National
2 percent above prime rate and a 15 percent compensating balance.

(a) Calculate the effective interest rate of both banks.
(b) Recommend which bank's line of credit Mime Theatrical Supply should accept.

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Solution Preview

We assume that the amount to be borrowed is $10,000

1st National Bank
The interest rate would be 9% (1% above prime). The interest amount for 1 year will be 10,000X9%=900. In a discounted loan, the interest is deducted upfront. A ...

Solution Summary

The solution explains how to calculate the effective interest rate and decide among the alternatives