Amazon's CFO is considering the fees charged by two banks in trying to determine which is best for her firm. First American (FA) charges a flat $0.11 per payment and First Western (FW) requires a minimum compensating balance of $500,000 plus $0.05 per payment. If Amazon's cost of funds is 8.50% and the expected number of payments per year is 900,000, which bank should be chosen and why?

Question

Quizplus · Accepted Answer

To determine the best bank, we need to calculate the total cost of each option.

First American (FA): 
Cost per payment = $0.11 
Total cost per year = $0.11 * 900,000 = $99,000

First Western (FW): 
Cost per payment = $0.05 
Compensating balance = $500,000 
Opportunity cost of compensating balance = 8.50% 
Interest income foregone = $500,000 * 8.50% = $42,500 
Total cost per year = $0.05 * 900,000 + $42,500 = $87,500

Comparing the two options, we can see that First Western (FW) is the better choice as it has a lower total cost of $87,500 compared to First American's (FA) total cost of $99,000. The savings by choosing FW over FA is $11,500.

Amazon's CFO Is Considering the Fees Charged by Two Banks