4. Cost of a bank loan

The Effective Annual Rate (EAR) captures the total cost of borrowing, including both interest costs and other fees associated with short-term borrowing.

You are the Vice President of Finance for Houma Heirloom Seed Company, and one of your duties is to negotiate terms for borrowing under your companys $3 million credit line. You need to borrow $1 million for one year to finance the receivables and inventory related to a new product line. (Note: You will need the full use of the $1 million, so any fees, interest, or balances will be in addition to the $1 million.)

Calculate the EAR for each alternative offered by your bank.

Option A: 6.00% annual rate on a simple-interest basis. There are no compensating balances and the interest is payable quarterly.

Option B: 5.70% discount interest. The face amount of the loan is repaid at the end of the year.

Option C: 5.75% discount interest, with compensating balances of $20,000 in a noninterest bearing account. The face amount of the loan is repaid at the end of the year, and the compensating balances are returned.

	The EAR of option A is .
	The EAR of option B is .
	The EAR of option C is .
	The best alternative for Houma Heirloom Seed Company is .