Suppose your firm is seeking a five-year, amortizing $900,000 loan with annual payments and your bank is offering you the choice between a $950,000 loan with a $50,000 compensating balance and a $900,000 loan without a compensating balance. If the interest rate on the $900,000 loan is 9.5 percent, how low would the interest rate on the loan with the compensating balance have to be in order for you to choose it?
A) 9.5 percent
B) 5.56 percent
C) 7.43 percent
D) Not enough information is given to determine

Question

Quizplus · Accepted Answer

The effective loan amount with the compensating balance is $900,000 ($950,000 - $50,000). To make the two loans equivalent, the interest rate on the $950,000 loan must be lower. Calculating the equivalent interest rate using the formula for amortizing loans, the rate comes out to approximately 7.43 percent.

Suppose Your Firm Is Seeking a Five-Year, Amortizing $900,000 Loan