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Activity 2-2 Case Analysis

The treasurer of Tin Mfg. Company is considering three bank loan alternatives for a $200,000 note over 10 years: 1) 18% interest paid at year-end with no compensating balance, resulting in an 18% annual percentage rate. 2) 16% interest with a 20% compensating balance, resulting in a 20% annual percentage rate. 3) 14% interest discounted with a 20% compensating balance, resulting in a 21.21% annual percentage rate. The first alternative has the lowest cost of credit and does not require a compensating balance, so it is recommended.

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Jazzie Soriano
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1K views3 pages

Activity 2-2 Case Analysis

The treasurer of Tin Mfg. Company is considering three bank loan alternatives for a $200,000 note over 10 years: 1) 18% interest paid at year-end with no compensating balance, resulting in an 18% annual percentage rate. 2) 16% interest with a 20% compensating balance, resulting in a 20% annual percentage rate. 3) 14% interest discounted with a 20% compensating balance, resulting in a 21.21% annual percentage rate. The first alternative has the lowest cost of credit and does not require a compensating balance, so it is recommended.

Uploaded by

Jazzie Soriano
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Activity 2-2 Case Analysis

Case 1
 The treasurer of the Tin Mfg. Company is faced with three alternative bank loans. The
firm wishes to select the one that minimizes the cost of credit on a P200,000 note that it
plans to issue in the next 10 days. Relevant information for the here loan configuration
is found below:        

a. An 18% rate of interest with interest paid at year-end and no compensating


balance requirement.
b. A 16% rate of interest but carrying a 20% compensating balance requirement.
This loan also calls for interest to be paid at year-end.
c. A 14% rate of interest that is discounted plus a 20% compensating balance
requirement.
 
Analyze the cost of each of these alternatives. You may assume that the firm would not
normally maintain any bank balance that might be used to meet the compensating
balance requirement of alternatives (b) and (c). Support your recommendation with
supporting computations.

COMPUTATION:

a. SIMPLE INTEREST LOAN


 Interest = P200,000 x 18% = P36,000

Percentage cost per period (rPER)= Interest


Face Value

= 36,000
200,000

(rPER)= 18%
Annual percentage rate (rAPR) = rPER X m

= 18% x 12/12
(rAPR)= 18%
Effective annual rate (rEAR) = (1 + rPER)m – 1

= (1 + 18%)20/20 -1

(rEAR)= 18%

b. SIMPLE INTEREST W/ COMPENSATING BALANCE


 Interest= P200,000 x 16% =32,000

Percentage cost per period (rPER)= Interest


Face Value – Compensating balance

= 32,000
200,000-40,000
(rPER)= 20%

Annual percentage rate (rAPR) = rPER X m

= 20% x 12/12
(rAPR)= 20%

Effective annual rate (rEAR) = (1 + rPER)m – 1

= (1 + 20%)20/20 -1

(rEAR)= 20%

c. DISCOUNTING W/ COMPENSATING BALANCE


 Interest= P200,000 x 14% =28,000

Percentage cost per period (rPER) = Interest


Face Value – Interest – Compensating balance

= 28,000
200,000-28,000-40,000
(rPER)= 21.21%
Annual percentage rate (rAPR) = rPER X m

= 21.21% x 12/12
(rAPR)= 21.21%

Effective annual rate (rEAR) = (1 + rPER)m – 1

= (1 + 21.21%)20/20 -1

(rEAR)= 21.21%
Recommendation:
Among the three alternative bank loans that Tin Mfg. Company treasurer is facing, the one that
minimizes the cost of credit on a P200 000 note that it plans to issue in the next 10 days is the first
alternative which is with an 18% rate of interest with interest paid at year-end and has no compensating
balance requirement. We recommend alternative A because its percentage rate is the lowest among the
three options and it does not also require compensating balance. In this alternative, the company can
maximize the utilization of its funds in running the company. Compared with alternative B, which has a
16% interest rate with a 20% compensating balance requirement which is deducted to the face value of
the loan which also means that the loan you will receive is lower which is an unfavourable option
compared to alternative A. Same as well with alternative C which is a 14% interest rate that is
discounted with a 20% compensating balance requirement. In this alternative, the company will need to
meet the compensating balance requirement because it has no maintaining balance in the bank and
specifically because it is discounted which means that the interest is deducted in advance that leads to a
higher interest rate than other alternatives.

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