On January 1, 2010, 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 that Lynn pays on its $2,000,000 loan, we need to take into account both the interest expense on the loan and the opportunity cost of keeping the compensating balance.

The interest expense on the loan is calculated as:

$2,000,000 x 11% = $220,000

The interest earned on the $200,000 compensating balance is calculated as:

$200,000 x 5% = $10,000

The effective interest rate that Lynn pays on its $2,000,000 loan is then:

($220,000 - $10,000) / $2,000,000 = 0.105 or 10.5%

However, we need to convert this to an annual rate by multiplying by 12/1 (since the loan is for one year), which gives us:

10.5% x 12/1 = 126/12 = 10.5%

Therefore, the answer is D) 11.6%.

On January 1, 2010, Lynn Company Borrows $2,000,000 from National