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18-7

Titman, 12e Paymaster Enterprises Short-term Bank Loan


Given: Interest Rate: 12% p.a. (DISCOUNTED)
Minimum Demand Deposit: 10% of Loan
Plan to borrow: $100,000 for 3 mos
Requirement:
1. Loan Amount
2. Interest Amount
3. Compensating Balance
4. APR or Cost of Bank Credit
18-7 Titman 12 e
A. Assumption: Paymaster is willing to take home an amount lesser than $100,000
- Paymaster borrows $100,000 + Compensating Balance

1. B = Amount Borrowed
B = $100,000.00 / 0.90
B = $111,111.11

2 . INT = $111,111.11 x 12.00% x 3 / 12


= $3,333.33

3 . Compensating Balance = 10% of Loan


= $111,111.11 x 10.00%
= $11,111.11

4 . APR = $3,333.33 x 1
($100,000 - $3,333.33) 3 / 12
= 13.79%
B. Assumption: Paymaster needs FULL AMOUNT of $100,000
- Paymaster borrows $100,000 + Compensating Balance + Interest Charge

1 . $100,000 = Loan - 0.10 Loan - (Loan x 0.12 x 3/12)


$100,000 = Loan - 0.10 Loan - 0.03 Loan
$100,000 = 0.87 Loan
B = $114,942.53

2 . INT = $114,942.53 x 12.00% x 3 / 12


= $3,448.28

3 . Compensating Balance = 10% of Loan


= $114,942.53 x 10.00%
= $11,494.25

4 . APR = $3,448.28 x 1
$100,000.00 3 / 12
= 13.79%
Check:
$100,000 = $114,942.53 - $11,494.25 - $3,448.28
18-9 Titman, 12e R. Morin Construction Company Short-term Financing
Given: Interest Rate: 14% p.a. (DISCOUNTED)
Compensating Balance: 15%
Minimum Demand Deposit Maintained: $25,000
Plan to borrow: $100,000 for 1 yr
Requirement:
1. Loan Amount
2. Interest Amount
3. Compensating Balance
4. APR or Cost of Bank Credit
18-9 Titman 12 e
A. Assumption: A. Morin is willing to take home an amount lesser than $100,000
- A. Morin has DD (C/A) Account with bank

1 . B = Amount Borrowed
B = $100,000.00

2 . INT = $100,000.00 x 14.00% x 12 / 12


= $14,000.00 - consider only DISCOUNTED INTEREST

3 . APR = $14,000.00 x 1
($100,000 - $14,000) 12 / 12
= 16.28%
4 . LOAN
PROCEEDS = $100,000.00 - $14,000.00
= $86,000.00
B. Assumption: A. Morin needs FULL AMOUNT of $100,000
- A. Morin borrows $100,000 + Interest Charge

1 . $100,000 = Loan - (Loan x 0.14 x 12/12)


$100,000 = Loan - 0.14 Loan
$100,000 = 0.86 Loan
B = $116,279.07

2 . INT = $116,279.07 x 14.00% x 12 / 12


= $16,279.07

3 . APR = $16,279.07 x 1
$100,000.00 12 / 12
= 16.28%
Check:
$100,000 = $116,279.07 - $16,279.07
C. Alternative B: Equipment Dealer Financing

Borrow $100,000, repays $116,300 after 1 yr

APR = $16,300.00 x 1
$100,000.00 12 / 12
= 16.30%

Essentially the same as the BANK LOAN if we ignore rounding-off

However, if we consider the DD Account of $25,000: Opportunity Cost


D. Assumption: A. Morin is willing to take home an amount lesser than $100,000
- Borrows $100,000 + Compensating Balance of 15%

1 . B = $100,000.00 / (100% - 15%)


B = $100,000.00 / 85% - to establish the compensating balance
B = $117,647.06

2 . INT = $117,647.06 x 14.00% x 12 / 12


= $16,470.59

3 . Compensating Balance = 15% of Loan


= $117,647.06 x 14.00%
= $16,470.59

4 . APR = $16,470.59 x 1
$83,529.41 12 / 12 Loan Proceeds: $83,529.41
= 19.72%

Thus, the Equipment Dealer is much better Alternative : 16.30%


E. Assumption: A. Morin needs the FULL AMOUNT of $100,000
- Borrows $100,000 + Compensating Balance of 15% + Discounted Interest

1 . $100,000 = Loan - 0.15 Loan - (Loan x 0.14 x 12/12)


$100,000 = Loan - 0.15 Loan - 0.14 Loan
$100,000 = 0.71 Loan
B = $140,845.07

2 . INT = $140,845.07 x 14.00% x 12 / 12


= $19,718.31

3 . Compensating Balance = 15% of Loan


= $140,845.07 x 15.00%
= $21,126.76

4 . APR = $19,718.31 x 1
$100,000.00 12 / 12 Loan Proceeds: $100,000.00
= 19.72%
Check:
$100,000 = $140,845.07 - $21,126.76 - $19,718.31

Thus, the Equipment Dealer is much better Alternative : 16.30%


18-12 Titman, 12e Jimmy Hale Short-term Bank Loan
Given: Interest Rate: 1% over prime: 8%. p.a.
Minimum Demand Deposit: 20% of Loan; Existing DD: $4,000
Plan to borrow: $240,000 for 3 mos
Requirement:
1. Loan Amount
2. Interest Amount
3. Compensating Balance
4. APR or Cost of Bank Credit
B. Assumption: J. Hale needs the FULL AMOUNT of $240,000
- J. Hale has DD (C/A) Account with bank: $4,000

1 . $240,000 = Loan - (0.20 Loan - $4,000)


$240,000 = ( 1 - 0.20) Loan + $4,000
$236,000 = 0.8 Loan
B = $295,000.00

2 . INT = $295,000.00 x 8.00% x 3 / 12


= $5,900.00 - NOT DISCOUNTED, will be repaid at end of term

3 . Compensating Balance = 20% of Loan


= $295,000.00 x 20.00%
= $59,000.00 less: DD $4,000 $55,000.00 - will come from the loan

4 . APR = $5,900.00 x 1
$240,000.00 3 / 12
= 9.83%
LOAN
PROCEEDS = $295,000.00 - $55,000.00
= $240,000.00
Tips:
1. Determine the Loan Amount (B) look for:
a. Amount that the borrower is willing to borrow:
- Not to exceed a specified amount (18-12, Titman 12e Jimmy Hale),
then B = specified amount
- Amount with Loan Proceeds lower than the specified amount, but an
amount that will cover compensating balance and discounted interest

2. Interest Amount
3. Compensating Balance
4. APR or Cost of Bank Credit
Tips:
1. Determine the Loan Amount (B) look for the AMOUNT that the borrower
is willing to borrow:
- Not to exceed a specified amount?
- Borrower willing to accept loan proceeds < specified amount?
- Compensating Balance (CB)? Existing account with the bank?
- Discounted Interest? or end-of-term settlement?
- Loan proceeds = Amount specified? - borrower needs the entire
amount, so B must be enough to cover interest and CB
2. INTEREST: B x rate% x time
3. Compensating Balance = % x Loan Amount (B)
4. APR = (INTEREST / Loan Proceeds ) x (1 / Time)