The effective annual interest rate on a loan in which a company borrows $1,000,000 for one year at 8 percent and requires a compensating balance of 10 percent is:

Question

Quizplus · Accepted Answer

The actual amount borrowed is $1,000,000 - ($1,000,000 x 10%) = $900,000.
The interest paid on the loan is $1,000,000 x 8% = $80,000.
The effective interest rate can be calculated using the following formula:
Effective Annual Interest Rate = (Interest Paid / Actual Amount Borrowed) x 100%
= ($80,000 / $900,000) x 100%
= 8.9%

The Effective Annual Interest Rate on a Loan in Which