Now assume that during the first quarter of 2013, Springfield announces a deal where it will be the exclusive supplier to a new major customer, leading to an overall sales increase of 20% for the firm.
Assume now, rather than charging a loan origination fee, Timmons’ bank requires that the firm keep an amount equal to 10% of the loan principal in a non-interest-bearing account with the bank as long as the loan remains outstanding.
RAXHouse has a $1,000,000 bank loan at 8% (APR with monthly compounding). The bank requires that RAXHouse maintain a 20% compensating balance. If RackHouse earns 2% (APR with monthly compounding) on its compensating balance accounts, what is the EAR of a six-month loan?
Applying the compensating balance toward the loan, RAXHouse will need $1,040,673 - $202,008 = $838,665 to pay off the loan. The six-month interest rate paid is $838,665/$800,000 -1 = 4.8331%. Thus, the EAR is 1.048331 2 -1 = 9.900%
27.4 Short-Term Financing with Commercial Paper
Short-term, unsecured debt issued by large corporations that is usually a cheaper source of funds than a short-term bank loan
Most commercial paper has a face value of at least $100,000.
Average maturity is 30 days and the maximum maturity is 270 days.
Commercial paper is rated by credit rating agencies.
27.4 Short-Term Financing with Commercial Paper (cont'd)
Commercial paper that a firm sells directly to investors
Commercial paper that dealers sell to investors in exchange for a spread (or fee) for their services
The spread decreases the proceeds that the issuing firm receives, thus increasing the effective cost of the paper.