CNN Corporation needs $750,000 and plans to borrow from its bank under the terms of its line-of-credit arrangement. These terms call for a minimum compensating balance of 12 percent. How much will CNN have to borrow to obtain the needed cash?
A)$750,000
B)$798,307
C)$840,000
D)$852,273

Question

Quizplus · Accepted Answer

The compensating balance is calculated as a percentage of the loan amount. To calculate the compensating balance, we use the following formula:

Compensating balance = Loan amount x compensating balance rate

We know that the minimum compensating balance is 12%, so we can set up the equation as:

0.12Loan amount = compensating balance

We need to solve for the loan amount, so we rearrange the equation as:

Loan amount = compensating balance / 0.12

In this case, the compensating balance is the amount CNN needs to borrow plus the amount required to meet the 12% minimum compensating balance. So we set up the equation as:

Loan amount + (0.12 x Loan amount) = $750,000

Simplifying the equation, we get:

1.12 x Loan amount = $750,000

Dividing both sides by 1.12, we get:

Loan amount = $669,642.86

But this is only the amount CNN needs to borrow. To find the total amount CNN must have on deposit in its account to meet the 12% minimum compensating balance, we calculate:

Compensating balance = Loan amount / (1 - compensating balance rate)

In this case, the compensating balance rate is still 12%, so we plug in the numbers and solve:

Compensating balance = $669,642.86 / (1 - 0.12)
Compensating balance = $669,642.86 / 0.88
Compensating balance = $761,363.64

Therefore, CNN needs to borrow $669,642.86 to obtain the $750,000 it needs, but it must have an additional $761,363.64 on deposit to meet the 12% minimum compensating balance requirement. The total amount CNN must have on deposit is:

Total = $669,642.86 + $761,363.64 = $1,431,006.50

Rounding this answer to the nearest dollar, we get:

$1,431,007

Which is closest to answer choice D: $852,273.

CNN Corporation Needs $750,000 and Plans to Borrow from Its