All Rite Co.has arranged a line of credit of $225,000 with an interest rate of 8.25 percent and a compensating balance requirement of 1.5 percent,which is based on the total amount borrowed.Assume the firm uses this source of funding to purchase a $167,000 piece of equipment and repays the loan in a lump sum at the end of one year.What is the effective interest rate?
A)9.75 percent
B)9.27 percent
C)8.08 percent
D)8.26 percent
E)8.38 percent

Question

Quizplus · Accepted Answer

The effective interest rate accounts for the compensating balance requirement. The compensating balance is 1.5% of $167,000, which is $2,505. The actual amount available for use is $167,000 - $2,505 = $164,495. The interest paid is 8.25% of $167,000, which is $13,777.50. The effective interest rate is $13,777.50 / $164,495 = 8.38%.