Florida Grape Growers (FGG)has a line of credit with Trust Company Bank that allows FGG to borrow up to $400,000 at an annual interest rate of 11 percent.However,FGG must keep a compensating balance of 25 percent of any amount borrowed on deposit at the Trust Company.FGG does not normally have a cash balance account with the Trust Company.What is the effective annual cost of credit?
A) 11.45%
B) 12.59%
C) 14.67%
D) 16.00%

Question

Quizplus · Accepted Answer

The effective annual cost of credit is calculated by considering the interest rate and the compensating balance requirement. The compensating balance effectively reduces the amount of usable funds, increasing the cost of borrowing. The formula for the effective interest rate is: Effective Rate = Stated Rate / (1 - Compensating Balance Percentage). Substituting the given values: 11% / (1 - 0.25) = 14.67%.

Florida Grape Growers (FGG)has a Line of Credit with Trust