Pierce Control Systems Case
Pierce Control Systems case 1. Based on the 10 percent compensating balance requirement, how much would Pierce Control Systems have to borrow to acquire $10 million in needed funds?
Solution: Compensating balance = 10% → 0.10 Amount needed = $10,000, 000
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Check: Loan = $11,111,111 Compensating balance = 10% → 0.10 = loan ∙ 0.10 = $11,111,111 ∙ 0.10 = $1,111,111
Available funds = Loan – Compensating Balance Available funds = $11,111,111 - $1,111,111 Available funds = [pic]
Answer: Pierce Control Systems would have to borrow $11,111,111 in order to acquire $10 million in needed funds with a 10 percent compensating balance.
2. Would the cost of the bank loan with the 10 percent compensating balance requirement and a 5 ½ percent rate applied to the total loan outstanding be more or less than the 6 percent prime rate loan on $10 million? Work this in terms of total dollar interest payments and compare the two answers.
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3. What if 4 percent interest could be earned on all funds kept in excess of the $10 million under the compensating balance loan arrangement? What would be the net dollar interest cost of the compensating balance loan arrangement? How does this compare to the 6 percent prime interest rate loan total dollar cost? 4. Based on the difference between 6 the percent prime (short-term) interest rate charged by the bank and the 8 percent longer-term interest rate charged by the insurance company, what does this tell you about the likely current shape of the term structure of interest rates? Based on the expectations hypothesis, what might you infer is the next most likely move in interest rates?
5. Assume the following projected interest rates for the prime rate over the next five years; what would be the total interest cost on the $10 million loan over that period? (Disregard the compensating balance alternative for purposes of this question.) How
Solution: Compensating balance = 10% → 0.10 Amount needed = $10,000, 000
[pic] [pic]
Check: Loan = $11,111,111 Compensating balance = 10% → 0.10 = loan ∙ 0.10 = $11,111,111 ∙ 0.10 = $1,111,111
Available funds = Loan – Compensating Balance Available funds = $11,111,111 - $1,111,111 Available funds = [pic]
Answer: Pierce Control Systems would have to borrow $11,111,111 in order to acquire $10 million in needed funds with a 10 percent compensating balance.
2. Would the cost of the bank loan with the 10 percent compensating balance requirement and a 5 ½ percent rate applied to the total loan outstanding be more or less than the 6 percent prime rate loan on $10 million? Work this in terms of total dollar interest payments and compare the two answers.
[pic]
3. What if 4 percent interest could be earned on all funds kept in excess of the $10 million under the compensating balance loan arrangement? What would be the net dollar interest cost of the compensating balance loan arrangement? How does this compare to the 6 percent prime interest rate loan total dollar cost? 4. Based on the difference between 6 the percent prime (short-term) interest rate charged by the bank and the 8 percent longer-term interest rate charged by the insurance company, what does this tell you about the likely current shape of the term structure of interest rates? Based on the expectations hypothesis, what might you infer is the next most likely move in interest rates?
5. Assume the following projected interest rates for the prime rate over the next five years; what would be the total interest cost on the $10 million loan over that period? (Disregard the compensating balance alternative for purposes of this question.) How