Question

(Cost of short- term bank loan) On July1,2015 , the Southwest Forging Corporation arranged for a line of
credit with the First National Bank (FNB) of Dallas. The term of the agreement call for a $100,000 maxinum loan
with interest set at 1 percent over prime. In addition, the firm has to maintain a 20 percent compensation sating
balance in its demand deposit account throught the year. The prime rate is currently 4.5 percent.
a . If Southwest normally maintains a $20,000 to $30,000 balance in its checking account with FNB of Dallas,
what is the effective cost of credit under the line-of-credit agreement when the maximum loan amount is used for
a full year?
b.Compute the effective cost of credit if the firm borrows the compensation balance and the maximum possible
amount under the loan agreement . Again, assume the full amount of the loan is outstanding for a whole year.

Answer 1