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A company has received a one-year commercial bank loan of 7.5% discounted interest with a 12.5% compensating balance. The effective annual cost of the bank loan is closest to?

  • 1.  A company has received a one-year commercial bank loan of 7.5% discounted interest with a 12.5% compensating balance. The effective annual cost of the bank loan is closest to?

    Posted 01-18-2022 04:33 AM
    A company has received a one-year commercial bank loan of 7.5% discounted interest with a 12.5% compensating balance. The effective annual cost of the bank loan is closest to?

    CAN ANYONE HELP ON THIS
    My answer to the Question :
    Assuming The Loan amount is 100
    interest -7.5%*100=7.5
    Actual Amount Received =100-12.5(compensating balance)=87.5
     
    effective Cost of BAnk loan =(7.5/87.5)*100=8.57%

    ANSWER GIVEN IN OTP

    In determining the effective cost of a bank loan with compensating balance and discounted interest rate, net interest cost and net proceeds should be computed. Net interest cost is the interest cost after any interest gained on compensating balance. Since the problem is silent on the interest income on compensating balance, the interest cost on the loan is only considered. This is 7.5% of the loan. The net proceeds is the net amount that the borrower gets when the loan is entered into. This is the loan amount less any discounted interest and less any compensating balance. This is computed as Loan x (100% In determining the effective cost of a bank loan with compensating balance and discounted interest rate, net interest cost and net proceeds should be computed. Net interest cost is the interest cost after any interest gained on compensating balance. Since the problem is silent on the interest income on compensating balance, the interest cost on the loan is only considered. This is 7.5% of the loan. The net proceeds is the net amount that the borrower gets when the loan is entered into. This is the loan amount less any discounted interest and less any compensating balance. This is computed as Loan x (100% less 7.5% discounted interest and less 20% compensating balance). The percentages are applied to the gross amount of the loan.

    Option d is correct. Assume that the loan is $100. 

    Gross Loan                                   $ 100
    Discounted interest                    7.5%
    Compensating balance             12.5%
    Net interest cost                         7.50         (100 x 7.5%)
    Net proceeds                              80.00        (100 – (100x 7.5%) – (100 x 12.5%))
    Effective interest rate                9.38%        (7.5/ 80)

     

    Option d is correct. Assume that the loan is $100. 

    Gross Loan                                   $ 100
    Discounted interest                    7.5%
    Compensating balance             12.5%
    Net interest cost                         7.50         (100 x 7.5%)
    Net proceeds                              80.00        (100 – (100x 7.5%) – (100 x 12.5%))
    Effective interest rate                9.38%        (7.5/ 80)

     

    Y THEY ARE DEDUCTING INTEREST AMOUNT FROM NET PROCEEDS?



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    Amal Abdul Rasheed
    Supervisor
    Dubai
    United Arab Emirates
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  • 2.  RE: A company has received a one-year commercial bank loan of 7.5% discounted interest with a 12.5% compensating balance. The effective annual cost of the bank loan is closest to?

    Posted 01-19-2022 01:13 AM
    Hi Amal,

    The simplest formula to solve such problems where discounted interest is given with compensating balance is,

                              stated rate%_________________
    1 - stated rate % - compensating balance %

    in this problem 7.5% is the stated rate & 12.5% compensating balance rate. You can solve these kind of similar questions with the help of this formula.

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    Jay Chowdhury
    Mumbai India
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