Would it be worth it to incur a compensating balance of $9,000 in order to get a 0.70 percent lower interest rate on a 1-year,pure discount loan of $250,000? A)Yes B)No C)Not enough information is given to determine The repayment on the $250,000 loan without the compensating balance would be $250,000 × (1 + i), vs.$259,000 × (1 + [i - 0.007]): $250,000 × (1 + i) $259,000 × (1 + [i - 0.007]) ($250,000/$259,000) × (1 + i) (1 + [i - 0.007]) 0)9653 + 0.9653i 1 + i - 0.007 -0)0347i 0.0277 I

Question

Would it be worth it to incur a compensating balance of $9,000 in order to get a 0.70 percent lower interest rate on a 1-year,pure discount loan of $250,000?
A)Yes
B)No
C)Not enough information is given to determine The repayment on the $250,000 loan without the compensating balance would be $250,000 × (1 + i), vs.$259,000 × (1 + [i - 0.007]):
$250,000 × (1 + i) > $259,000 × (1 + [i - 0.007])
($250,000/$259,000) × (1 + i) > (1 + [i - 0.007])
0)9653 + 0.9653i > 1 + i - 0.007
-0)0347i > 0.0277
I < -0.7983
In other words, only if the rate is less than -79.83 percent.Since this is not likely to happen, the lower rate associated with the compensating balance isn't worth it.

Quizplus · Accepted Answer

The calculation shows that the interest rate would need to be less than -79.83 percent in order for it to be worth it to incur the $9,000 compensating balance. As this is not a realistic interest rate, it is not worth it to incur the compensating balance for the 0.70 percent lower interest rate on the loan. Therefore, the best choice is option B, which is "No".

Would It Be Worth It to Incur a Compensating Balance