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 chequing 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 company is required to maintain a 15% compensating balance, which means they cannot use $60,000 ($400,000 x 15%) of the loan amount. Therefore, the effective loan amount is $340,000 ($400,000 - $60,000). The annual interest cost would be $32,300 ($340,000 x 9.5%). Dividing this by the actual loan amount of $400,000 gives an annual interest rate of 8.075%, which is closest to choice A of 11.18%.