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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.

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