Francis Construction Co. has an outstanding 180-day bank loan of $600,000 at an annual interest rate of 8%. The company is required to maintain a 20% 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.

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Quizplus · Accepted Answer

The effective annual interest rate is:EAR = (1 + (APR/360) * (360 + (20% * 180))) / (1 - (20% * 180/360)) - 1= (1 + (0.08/360) * (360 + (0.20 * 180))) / (1 - (0.20 * 180/360)) - 1= (1 + (0.08/360) * (360 + 36)) / (1 - (0.20 * 180/360)) - 1= (1 + (0.08/360) * 396) / (1 - (0.20 * 180/360)) - 1= (1 + 0.088) / (1 - 0.10) - 1= 1.088 / 0.9 - 1= 0.10 - 1= 0.10 or 10%