Would It Be Worth It to Incur a Compensating Balance

question 123

Multiple Choice

Would it be worth it to incur a compensating balance of $2,000 in order to get a 1.5-percent-lower interest rate on a 1-year,pure discount loan of $100,000?

• A)Yes
• B)No
• C)Not enough information is given to determine It depends upon whether $100,000 × (1 + i) or $102,000 × (1 + [i - 0.015]) is larger.The compensating balance for the lower loan rate will make sense if:
• $100,000 × (1 + i) > $102,000 × (1 + [i - 0.015])
• ($100,000/$102,000) × (1 + i) > (1 + [i - 0.015])
• 0)9804 + 0.9804i > 1 + i - 0.015
• -0)0196i > 0.0046
• I < -0.234694
• In other words, only if the rate is less than -23.47 percent.Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it.

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Definitions:

Stockholders' Equity

The ownership interest of shareholders in a company, represented by the company's assets minus its liabilities.

Earnings Per Share

A company's profit divided by its number of outstanding shares of common stock, indicating the profitability available to shareholders on a per-share basis.

Current Ratio

A financial metric assessing a firm's capacity to meet its short-term debts due within a year, determined by dividing its current assets by its current liabilities.

Company

A legal entity formed by a group of individuals to engage in and operate a business enterprise.