On January 1, 2014, Lynn Company borrows $2,000,000 from National Bank at 11% annual interest. In addition, Lynn is required to keep a compensatory balance of $200,000 on deposit at National Bank which will earn interest at 5%. The effective interest that Lynn pays on its $2,000,000 loan is

Question

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To calculate the effective interest rate paid by Lynn Company, we need to take into account the interest paid on the loan as well as the interest earned on the compensatory balance.

Interest on the loan = $2,000,000 x 11% = $220,000

Interest earned on the compensatory balance = $200,000 x 5% = $10,000

The total amount of interest expense for Lynn is the interest on the loan minus the interest earned on the compensatory balance, which is $220,000 - $10,000 = $210,000.

To calculate the effective interest rate, we divide the total interest expense by the amount of the loan, and then multiply by 100%:

Effective interest rate = ($210,000 / $2,000,000) x 100% = 10.5%

However, we also need to take into account the compensatory balance requirement. Since Lynn Company must keep $200,000 on deposit at National Bank, it is effectively only borrowing $1,800,000 ($2,000,000 - $200,000). This means that the effective interest rate is actually higher than 10.5%.

To calculate the true effective interest rate, we need to divide the total interest expense by the amount of funds actually borrowed (i.e. $1,800,000). This gives us:

True effective interest rate = ($210,000 / $1,800,000) x 100% = 11.67%

Rounded to one decimal place, the effective interest rate is 11.6%, so the correct answer is D.

On January 1, 2014, Lynn Company Borrows $2,000,000 from National