Effective interest rate: Serengeti Travels has borrowed $50,000 at a stated APR of 8.5 percent. The loan calls for a compensating balance of 8 percent. What is the effective interest rate for this company?

Question

Quizplus · Accepted Answer

To calculate the effective interest rate, we need to take into account the compensating balance required by the lender.

First, we need to calculate the amount of the compensating balance:
Compensating balance = Loan amount x Compensating balance rate
Compensating balance = $50,000 x 8% = $4,000

Next, we need to calculate the interest paid on the loan:
Interest = Loan amount x Stated APR
Interest = $50,000 x 8.5% = $4,250

Finally, we can calculate the effective interest rate:
Effective interest rate = (Interest + Compensating balance) / Loan amount
Effective interest rate = ($4,250 + $4,000) / $50,000
Effective interest rate = 8.50%

Therefore, the effective interest rate for Serengeti Travels is 9.24%.

Effective Interest Rate: Serengeti Travels Has Borrowed $50,000 at a Stated