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 20 percent is:

Question

Quizplus · Accepted Answer

The effective interest rate is calculated by considering the actual amount available for use after the compensating balance is deducted. The compensating balance is 20% of $1,000,000, which is $200,000. Therefore, the company effectively borrows $800,000 but pays interest on the full $1,000,000. The interest paid is $80,000 (8% of $1,000,000). The effective interest rate is $80,000 / $800,000 = 10%.

The Effective Annual Interest Rate on a Loan in Which