Problem - Summit Record Company is negotiating with two banks for a $104,000 loan. Fidelity Bank requires a compensating balance of 22 percent, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a compensating balance of 11 percent, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 10 percent. Compensating balances will be subtracted from the $104,000 in determining the available funds in part a.
a-1. Calculate the effective interest rate for Fidelity Bank and Southwest Bank.
a-2. Which loan should Summit accept?
Southwest Bank
Fidelity Bank
b. Recompute the effective cost of interest, assuming that Summit ordinarily maintains $22,880 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?