Ajax Box Company is negotiating with two banks for a $100,000 loan. Midland Bank requires a 20 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Central Bank requires a 10 percent compensating balance and does not discount the loan, but it wants to be paid back in 12 monthly installments. The stated rate at both banks is 8 percent. Compensating balances and any discounts will be subtracted from the $100,000 in determining the available funds in part a.
a. Which loan should Ajax accept?
b. Recompute the annual cost of interest, assuming Ajax ordinarily maintains $20,000 at each bank in deposits that will serve as compensating balances.
c. How much did the compensating balances inflate the percentage interest costs? Does your choice of banks change if the assumption in part b is correct?