In order to borrow $100,000 for a 5% loan on a discount loan basis with a 5% compensating balance;the firm will actually have to borrow:

Question

Quizplus · Accepted Answer

A discount loan means that the interest is deducted from the loan amount upfront, and the borrower receives the net amount. In this case, the loan amount is $100,000, and the interest rate is 5%, which means the borrower will receive:

$100,000 - (5% x $100,000) = $95,000

However, there is also a compensating balance requirement of 5%, which means that the borrower must maintain a balance of 5% of the loan amount in their account with the lender. This means they cannot use the full $95,000, but must maintain a balance of $5,000 with the lender.

Therefore, the actual amount the firm will receive is:

$100,000 / (1-0.05) = $105,263.16

This is the amount the firm needs to maintain a balance of $5,000 with the lender. To find the total amount the firm needs to borrow, we add the $5,000 compensating balance to this amount:

$105,263.16 + $5,000 = $110,263.16

Rounding to the nearest dollar gives us:

$111,111.

So the best choice is B) $111,111.

In Order to Borrow $100,000 for a 5% Loan on a Discount