The Babco Co.has a $200,000 line of credit with an 8% interest rate and a 10% compensating balance requirement that is based on the total amount borrowed.What is the effective interest rate if the firm uses this source of funding to purchase a $117,000 piece of equipment? The company plans on repaying the loan in a lump sum at the end of one year.

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The effective interest rate is calculated by considering the compensating balance requirement. The firm needs to borrow $130,000 to have $117,000 available after the 10% compensating balance. The interest on $130,000 at 8% is $10,400. The effective interest rate is $10,400 divided by the $117,000 actually available, which is approximately 8.89%.