Effective rate under different terms
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Your company plans to borrow $5 million for 12 months, and your banker gives you a stated rate of 14% interest. You would like to know the effective rate of interest for te following types of loans. (Each of the following parts stands alone.)
a. simple 14% interest with a 10% compensating balance
b. discounted interest.
c. an installment loan (12 months)
d. discounted interest with a 5% compensating balance.
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The solution explains how to calculate the effective rate under different terms
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a. Amount borrowed with compensating balance = 5,000,000/(1-0.1) = 5,555,555.56
Interest paid = 5,555,555.56 X 14% = 777,777.78
Effective rate = 777,777.78 / 5,000,000 (amount actually used) = 15.56%
b. In discounted ...
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