Question: Summit Record Company is negotiating with two banks for a $100,000 loan. Fidelity Bank requires a 20 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a 10 percent compensating balance, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 9 percent. Compensating balances will be subtracted from the $100,000 in determining the available funds in part a. Which loan should Summit accept?
b. Recompute the effective cost of interest, assuming that Summit ordinarily maintains $20,000 at each bank in deposits that will serve as compensating balances.
c. Does your choice of banks change if the assumption in part b is correct?