Pietro estimated that a pair of Style King jeans would be worth 50 for its brand and durability. However, at the Style King stor
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Answer:
Ans. The effective interest rate on the loan if the firm needs to borrow $75,000 for one year would be 7.37% effective annual.
Explanation:
Hi, well, first we need to establish the amount to be borrowed, taking into account that there is a compensating balance of 5%. This means that the 5% of the loan goes into an account that pays no interest, and that will happen for a year.
First we need to find the amount to be borrowed, that is:
Ok, that means that we need to ask for $78,947.37, the compensating balance is $78,947.37*0.05=3,947.37, that means that Fancy Footwear will receive: $78,947.37 - 3,947.37 = 75,000.
Now, the amount to be paid at the end of the loan can be calculated with the following equation:
Where:
Future Value= Is the money to be paid to the bank
Present Value= The money that Fancy Footwear has borrowed
r = The effective annual rate on the amount borrowed.
n= Periods (in years) to pay the loan
Everything looks like this.
Therefore, we need to pay $84,473.37, but we can now get our compensating balance, so our real cash flow in year 1 (1 year after the credit) is $84,473.68 - $3,947.37 = $80,526.32
In order to find the effective interest rate of this loan, we can use MS Excel and use the function "IRR" or, solve the following equation for R.
That is:
SO, the effective cost of the debt is 7.37% effective annually.
Best of luck