Midland Chemical Co.

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Midland Chemical CO. Midland Chemical Co. Anastasia Gallegos FIN/200 March 4, 2012 Melissa Drayton Midland Chemical Co. Midland Chemical Co. is negotiating a loan from Manhattan Bank and Trust. The small chemical company needs to borrow $500,000. The bank offers a rate of 8 ¼ percent with a 20 percent compensating balance requirement, or as an alternative, 9 ¾ percent with additional fees of $5,500 to cover services the bank is providing. In either case the rate on the loan is floating (changes as the prime rate changes), and the loan would be for one year. a. Which loan carries the lower effective rate? Consider fees to be the equivalent of other interest. Loan with a compensating balance. $500,000 at 8.25% = Interest at $41,250 With a $500,000 loan the 20% compensating balance requirement would be $100,000 which leaves $400,000 in available funds. To calculate the effective rate, divide interest by available funds. $41,250/400,000 = 10.312% Loan with fee added. $500,000 at 9.75% = interest at $48,750 The interest plus the fee $48,750 + $5,500 = $54,250 To calculate the effective rate, divide the interest plus fees by the loan amount, $54,250/$500,000 =10.850% The loan with the compensating requirement has the lower effective cost at 10.312%. b. If the loan with a 20 percent compensating balance requirement were to be paid off in 12 monthly payments, what would the effective rate be? (Principal equals amount borrowed minus the compensating balance.) The effective rate on an installment loan is calculated through the formula 2 times annual no. of payments times the interest divided by the total number of payments plus 1 multiplied by the principal. 2*12*$41,250 = $990,000. (12+1)*$400,000 = $5,200,000. $990,000 / $5,200,000 = 19.038% c. Assume the proceeds from the loan with the compensating balance requirement will be used to take

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