Juno Industrial Supply has a line of credit of $200,000 with an interest rate of 7.1 percent. The loan agreement requires a compensating balance of 3.3 percent of the total amount borrowed, which will be held in an interest-free account. What is the effective interest rate if the company requires $132,000 for operations for one year?

Question

Quizplus · Accepted Answer

The effective interest rate can be calculated by considering the actual amount available for use after accounting for the compensating balance. The compensating balance is 3.3% of $132,000, which is $4,356. Therefore, the actual amount available for use is $132,000 - $4,356 = $127,644. The interest for one year on the borrowed amount ($132,000) at 7.1% is $9,372. The effective interest rate is then calculated as the interest paid divided by the actual amount available for use, which is $9,372 / $127,644 = 0.0734 or 7.34%.

Juno Industrial Supply Has a Line of Credit of $200,000