National Manufacture Company In Butwal Wishes To Borrow Rs. 1,000,000 For 1 Year. It Must Choose One Of The Following Alternatives:a) A 12 Percent Simple Interest Loan With A 5 Percent Compensating Balance.b) A 16 Percent Discounting Loan With No

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Introduction

In today's business landscape, companies often require loans to finance their operations, expand their business, or meet their short-term needs. National Manufacture Company in Butwal is one such company that wishes to borrow Rs. 1,000,000 for a period of 1 year. The company must choose between two loan options: a 12 percent simple interest loan with a 5 percent compensating balance, and a 16 percent discounting loan with no compensating balance. In this article, we will compare these two loan options and help the company make an informed decision.

Understanding Simple Interest Loan

A simple interest loan is a type of loan where the interest is calculated only on the principal amount borrowed. The interest is calculated as a percentage of the principal amount, and it is not compounded. In the case of National Manufacture Company, the 12 percent simple interest loan means that the company will have to pay an interest of Rs. 120,000 (12 percent of Rs. 1,000,000) at the end of the 1-year period.

Understanding Discounting Loan

A discounting loan is a type of loan where the lender discounts the face value of the loan by a certain percentage. The face value of the loan is the amount that the borrower is eligible to receive, and the discount is the amount that the borrower has to pay to the lender. In the case of National Manufacture Company, the 16 percent discounting loan means that the company will have to pay a discount of Rs. 160,000 (16 percent of Rs. 1,000,000) at the beginning of the 1-year period.

Calculating Effective Interest Rate

The effective interest rate is the rate that reflects the total cost of the loan, including the interest and any fees. To calculate the effective interest rate, we need to calculate the total interest paid over the 1-year period and divide it by the principal amount.

For the 12 percent simple interest loan, the total interest paid is Rs. 120,000, and the effective interest rate is:

Effective Interest Rate = (Total Interest / Principal) x 100 = (120,000 / 1,000,000) x 100 = 12%

For the 16 percent discounting loan, the total interest paid is Rs. 160,000, and the effective interest rate is:

Effective Interest Rate = (Total Interest / Principal) x 100 = (160,000 / 1,000,000) x 100 = 16%

Comparing Loan Options

Now that we have calculated the effective interest rate for both loan options, we can compare them. The 12 percent simple interest loan has an effective interest rate of 12 percent, while the 16 percent discounting loan has an effective interest rate of 16 percent. This means that the 12 percent simple interest loan is cheaper than the 16 percent discounting loan.

However, we also need to consider the compensating balance requirement for the 12 percent simple interest loan. The company must maintain a compensating balance of 5 percent of the loan amount, which is Rs. 50,000. This means that the company will not be able to use the full amount of Rs. 1,000,000 for its business operations.

Conclusion

In conclusion, National Manufacture Company in Butwal has two loan options to choose from: a 12 percent simple interest loan with a 5 percent compensating balance, and a 16 percent discounting loan with no compensating balance. While the 12 percent simple interest loan is cheaper, the company must consider the compensating balance requirement and the fact that it will not be able to use the full amount of the loan for its business operations. On the other hand, the 16 percent discounting loan is more expensive, but it does not have any compensating balance requirement.

Ultimately, the decision between these two loan options depends on the company's financial situation and its business needs. The company should carefully consider its options and choose the loan that best suits its needs.

Recommendation

Based on the calculations and analysis above, we recommend that National Manufacture Company in Butwal choose the 12 percent simple interest loan with a 5 percent compensating balance. While the loan is cheaper, the company must carefully consider the compensating balance requirement and the fact that it will not be able to use the full amount of the loan for its business operations.

However, if the company is unable to meet the compensating balance requirement or if it needs to use the full amount of the loan for its business operations, it may be better to choose the 16 percent discounting loan. The company should carefully consider its options and choose the loan that best suits its needs.

Future Considerations

In the future, National Manufacture Company in Butwal may want to consider other loan options, such as a line of credit or a term loan. These types of loans may offer more flexibility and better terms than the simple interest loan or the discounting loan.

Additionally, the company may want to consider working with a financial advisor or a loan broker to help it navigate the loan process and find the best loan option for its needs.

Conclusion

In conclusion, National Manufacture Company in Butwal has two loan options to choose from: a 12 percent simple interest loan with a 5 percent compensating balance, and a 16 percent discounting loan with no compensating balance. While the 12 percent simple interest loan is cheaper, the company must carefully consider the compensating balance requirement and the fact that it will not be able to use the full amount of the loan for its business operations. On the other hand, the 16 percent discounting loan is more expensive, but it does not have any compensating balance requirement.

Q: What is the difference between a simple interest loan and a discounting loan?

A: A simple interest loan is a type of loan where the interest is calculated only on the principal amount borrowed. The interest is calculated as a percentage of the principal amount, and it is not compounded. On the other hand, a discounting loan is a type of loan where the lender discounts the face value of the loan by a certain percentage.

Q: What is the effective interest rate, and how is it calculated?

A: The effective interest rate is the rate that reflects the total cost of the loan, including the interest and any fees. To calculate the effective interest rate, we need to calculate the total interest paid over the 1-year period and divide it by the principal amount.

Q: What is a compensating balance, and why is it required for the 12 percent simple interest loan?

A: A compensating balance is a requirement for some loans, where the borrower must maintain a certain amount of funds in a separate account. In the case of the 12 percent simple interest loan, the borrower must maintain a compensating balance of 5 percent of the loan amount, which is Rs. 50,000.

Q: Why is the 12 percent simple interest loan cheaper than the 16 percent discounting loan?

A: The 12 percent simple interest loan is cheaper than the 16 percent discounting loan because it has a lower effective interest rate. The effective interest rate for the 12 percent simple interest loan is 12 percent, while the effective interest rate for the 16 percent discounting loan is 16 percent.

Q: What are the pros and cons of each loan option?

A: The pros and cons of each loan option are as follows:

  • 12 percent simple interest loan:
    • Pros: cheaper, lower effective interest rate
    • Cons: requires a compensating balance, borrower cannot use the full amount of the loan for business operations
  • 16 percent discounting loan:
    • Pros: no compensating balance requirement, borrower can use the full amount of the loan for business operations
    • Cons: more expensive, higher effective interest rate

Q: What should National Manufacture Company in Butwal consider when choosing a loan option?

A: National Manufacture Company in Butwal should consider the following factors when choosing a loan option:

  • The company's financial situation and its ability to meet the loan requirements
  • The company's business needs and its ability to use the loan for its operations
  • The effective interest rate and the total cost of the loan
  • The compensating balance requirement and the borrower's ability to meet it

Q: Can National Manufacture Company in Butwal consider other loan options, such as a line of credit or a term loan?

A: Yes, National Manufacture Company in Butwal can consider other loan options, such as a line of credit or a term loan. These types of loans may offer more flexibility and better terms than the simple interest loan or the discounting loan.

Q: What should National Manufacture Company in Butwal do if it is unable to meet the compensating balance requirement for the 12 percent simple interest loan?

A: If National Manufacture Company in Butwal is unable to meet the compensating balance requirement for the 12 percent simple interest loan, it may be better to choose the 16 percent discounting loan. The company should carefully consider its options and choose the loan that best suits its needs.

Q: Can National Manufacture Company in Butwal work with a financial advisor or a loan broker to help it navigate the loan process?

A: Yes, National Manufacture Company in Butwal can work with a financial advisor or a loan broker to help it navigate the loan process. A financial advisor or a loan broker can provide guidance and support to help the company make an informed decision about its loan options.