8. Compensating Balances. Suppose that Dynamic Sofa (a subsidiary of Dynamic Mattress) has a line of credit with a stated interest rate of 10% and a compensating balance of 25%. The com- pensating balance earns no interest. (LOS)

a. If the firm needs $10,000, how much will it need to borrow?

b. Suppose that Dynamic's bank offers to forget about the compensating balance require- ment if the firm pays interest at a rate of 12%. Should the firm accept this offer? Why or why not?

c. Redo part

(b) assuming the compensating balance pays interest of 4%. Warning: You cannot use the formula in the chapter for the effective interest rate when the compensat- ing balance pays interest. Think about how to measure the effective interest rate on this loan.