here is the problem

The small chemical company needs to borrow $500,000. The bank offers a rate of 8 1/4 percent with a 20 percent compensating balance requirement, or as an alternative, 9 3/4 percent with additional fees of $5,500 to cover services the bank is providing. In either case the rate on the loan is floating (changes as the prime interest rate changes), and the loan would be for one year.

*Which loan carries the lower effective rate? Consider fees to be the equivalent of other interest.

*If the loan with a 20 percent compensating balance requirement were to be paid off in 12 monthly payments, what would the effective rate be? (Principal equals amount borrowed minus the compensating balance.)

*Assume the proceeds from the loan with the compensating balance requirement will be used to take cash discounts. Disregard part b about installment payments and use the loan cost from part a. If the terms of the cash discount are 1.5/10, net 50, should the firm borrow the funds to take the discount?

*Assume the firm actually takes 80 days to pay its bills and would continue to do so in the future if it did not take the cash discount. Should it take the cash discount?

*Because the interest rate on the loans is floating, it can go up as interest rates go up. Assume that the prime rate goes up by 2 percent and the quoted rate on the loan goes up the same amount. What would then be the effective rate on the loan with compensating balances? Convert the interest to dollars as the first step in your calculation.

*In order to hedge against the possible rate increase described in part e, Midland decides to hedge its position in the futures market. Assume it sells $500,000 worth of 12-month futures contracts on Treasury bonds. One year later, interest rates go up 2 percent across the board and the Treasury bond futures have gone down to $488,000. Has the firm effectively hedged the 2 percent increase in interest rates on the bank loan as described in part e? Determine the answer in dollar amounts.

I have no idea how to do this can you please give me ideas or help? Thank You

Until Reiny or Mathmate see this, my suggestion is to treat it like a word problem. Take each paragraph separate, take notes. Look up each word/term you don't understand first. Then decide what exactly you have to search. Google is a great search tool For example, I searched "caculations involving loans, cash discounts" (because this is definitely NOT my area of expertise) and this what came up, with lots of things that do not look like they would be any help but a couple that did look promising. When you do any search, select carefully what to open.

(Broken Link Removed)

Also, there are many tutorials online. If the subject matter is Financial Management, try searching "Financial Management Tutorial"

Good luck!

Sra

Certainly! I'll break down each question for you and explain how to approach it step by step:

1. Which loan carries the lower effective rate? Consider fees to be the equivalent of other interest.

To compare the effective rates of the two loans, you need to calculate the interest expense of each loan, including any fees. The formula for calculating effective rate is:

Effective Rate = (Interest Expense / Loan Amount) * 100

For the first loan with a 20% compensating balance requirement, calculate the interest expense by deducting the compensating balance from the loan amount and multiply it by the interest rate. Then, calculate the effective rate using the formula above.

For the second loan, simply add the additional fees to the loan amount, calculate the interest expense, and then compute the effective rate.

2. If the loan with a 20 percent compensating balance requirement were to be paid off in 12 monthly payments, what would the effective rate be? (Principal equals amount borrowed minus the compensating balance.)

In this case, you need to calculate the interest expense on a monthly basis for the loan, considering the monthly payments. Deduct the compensating balance from the loan amount, calculate the monthly payment amount, and determine the total interest paid over the year. Finally, use the formula mentioned earlier to find the effective rate.

3. Assume the proceeds from the loan with the compensating balance requirement will be used to take cash discounts. Disregard part b about installment payments and use the loan cost from part a. If the terms of the cash discount are 1.5/10, net 50, should the firm borrow the funds to take the discount?

To answer this question, compare the effective rate of the loan with the cash discount rate. The cash discount rate of 1.5% indicates the savings the firm would receive if it paid within the discount period. If the effective rate of the loan is lower than the cash discount rate, it would be beneficial to borrow the funds and take the discount.

4. Assume the firm actually takes 80 days to pay its bills and would continue to do so in the future if it did not take the cash discount. Should it take the cash discount?

To determine whether the firm should take the cash discount, compare the effective rate of the loan to the cost savings from the cash discount applied for 80 days. Calculate the cost of borrowing for 80 days using the effective rate, and compare it to the discount savings. If the savings outweigh the borrowing cost, it would be advantageous to take the cash discount.

5. Because the interest rate on the loans is floating, it can go up as interest rates go up. Assume that the prime rate goes up by 2 percent, and the quoted rate on the loan goes up the same amount. What would then be the effective rate on the loan with compensating balances? Convert the interest to dollars as the first step in your calculation.

To find the new effective rate on the loan with compensating balances, you first need to determine the increased interest expense due to the change in the prime rate. Calculate the dollar amount of the interest increase, deduct the compensating balance, and then determine the effective rate using the formula mentioned earlier.

6. In order to hedge against the possible rate increase described in part e, Midland decides to hedge its position in the futures market. Assume it sells $500,000 worth of 12-month futures contracts on Treasury bonds. One year later, interest rates go up 2 percent across the board, and the Treasury bond futures have gone down to $488,000. Has the firm effectively hedged the 2 percent increase in interest rates on the bank loan as described in part e? Determine the answer in dollar amounts.

To determine if the firm has effectively hedged the 2 percent increase in interest rates, you need to calculate the changes in the value of the futures contracts due to the interest rate increase. Subtract the value of the futures contracts after the interest rate increase from the original value of $500,000. The difference will indicate whether the firm effectively hedged against the increase in interest rates.

Remember, for each question, carefully follow the steps and formulas provided to calculate the required values and rates.