Holland Construction Co. has an outstanding 180-day bank loan of $400,000 at an annual interest rate of 9.5%. The company is required to maintain a 15% compensating balance in its chequeing account. What is the annual interest cost on the loan? Assume the company would not normally maintain this average amount.

Question

Quizplus · Accepted Answer

To calculate the annual interest cost on the loan, we need to first calculate the amount of interest paid.

Interest = Principal x Rate x Time

The principal is $400,000 and the rate is 9.5%. The time period is 180 days or 0.49 years (since there are 365 days in a year).

Interest = $400,000 x 0.095 x 0.49 = $18,620

Now, Holland Construction Co. is required to maintain a 15% compensating balance in its chequeing account. This means that they must maintain 15% of the loan amount ($60,000) in their chequing account to satisfy the bank's requirement.

Since the company would not normally maintain this average amount, we can consider this amount as an additional cost.

Annual interest cost = Interest / (Principal - Compensating Balance)

Annual interest cost = $18,620 / ($400,000 - $60,000) = 11.18%

Therefore, the answer is A) 11.18%.