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Loans and Effective Interest Rates

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Columbus shipping co is negotiating with 2 banks for a 100,000 loan. Bankcorp of Ohio requires a 20 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Cleveland bank requires a 10 percent compensating balance does not discount the loan but wants to be paid back in 12 monthly installments. The stated rate for both banks is 10% percent. Compensating balances and any discounts will be subtracted from the 100,000 in determining the available funds in part a.

a. Which loan should Columbus accept?
b. Recomputed the effective cost of interest, assuming Columbus ordinarily maintains $20,000 at each bank in deposits that will serve as compensating balances.
c. How much did the compensating balances inflate the percentage interest costs? Does your choice of backs change if the assumption in part b is correct?

Please show the calculations and formulas you use. Our book has
Effective rate on discounted loan interest/principal - interest X days in the year (360)/daysloan is outstanding AND
Effective rate with compensating balances = Interest/principal-compensating balance in $ X days in the year (360)/days loan is outstanding

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Solution Summary

The solution explains how to calculate the effective interest rate on a loan.