Smithfield's has a line of credit with a local bank of $50,000.The loan agreement calls for interest of 9 percent with a 5 percent compensating balance requirement that is based on the total amount borrowed.What is the effective interest rate if the firm needs $45,000 for one year to finance a fixed asset purchase?

Question

Quizplus · Accepted Answer

Amount borrowed = $45,000/(1 - .05)= $47,368.42Annual interest = $47,368.42 × .09 = $4,263.16Effective interest rate = $4,263.16/$45,000 = .0947,or 9.47%

Smithfield's Has a Line of Credit with a Local Bank