1.Example 15.2 Compensating balance change 10% to 7% and rework

Calculating the Effective Annual Cost of Short-Term Bank Credit

M&M Beverage Company has a $300,000 line of credit that requires a compensating balance equalto 20 percent of the loan amount. The rate paid on the loan is 10 percent per annum; $200,000 is borrowed for a 6-month period deposit with the lending bank. The dollar cost of the loan includes the interest expense and the opportunity cost of maintaining and idle cash balance equal to the 20 percent compensating balance. To accommodate the cost of the compensating-balance requirement, assume that the added funds will have to be borrowed and simply left idle in the firm's checking accounts.