Would it be worth it to incur a compensating balance of $15,000 in order to get a 2-percent-lower interest rate on a 1-year, pure discount loan of $1,000,000? A) yes B) no C) not enough information is given to determine It depends upon whether $1,000,000 x (1 + i) or $1,015,000 x (1 + [i - .02]) is larger. The compensating balance for the lower loan rate will make sense if: $1,000,000 x (1 + i) $1,015,000 x (1 + [i - .02]) ($1,000,000/$1,015,000) x (1 + i) (1 + [i - .02]) )9852 + .9852i 1 + i - .02 -)0148i -.0052 I

Question

Would it be worth it to incur a compensating balance of $15,000 in order to get a 2-percent-lower interest rate on a 1-year, pure discount loan of $1,000,000?
A) yes
B) no
C) not enough information is given to determine It depends upon whether $1,000,000 x (1 + i) or $1,015,000 x (1 + [i - .02]) is larger. The compensating balance for the lower loan rate will make sense if:
$1,000,000 x (1 + i) > $1,015,000 x (1 + [i - .02])
($1,000,000/$1,015,000) x (1 + i) > (1 + [i - .02])
)9852 + .9852i > 1 + i - .02
-)0148i > -.0052
I < .35135
In other words, only if the rate is less than 35.14%. Since this is likely to happen, the lower rate associated with the compensating balance is worth it.

Quizplus · Accepted Answer

Based on the calculation provided, the lower rate associated with incurring a compensating balance of $15,000 is worth it as long as the interest rate is less than 35.14%. Since this is likely to occur, it makes financial sense to take advantage of the lower interest rate and incur the compensating balance.

Would It Be Worth It to Incur a Compensating Balance