Effective interest rate: Good Homes Furnishings is borrowing $225,000. The loan requires a 10 per cent compensating balance, and the effective interest rate on the loan is 8.25 per cent. What is the stated APR on this loan? Round to one decimal place.

Question

Quizplus · Accepted Answer

To calculate the stated APR, we need to find out the total amount of interest paid on the loan over a year (assuming the loan is for a year) and divide it by the amount borrowed.

First, we need to find the actual amount borrowed after accounting for the compensating balance.

Compensating balance = $225,000 x 10% = $22,500

Actual amount borrowed = $225,000 - $22,500 = $202,500

Next, we need to find the interest paid over a year at an effective interest rate of 8.25%.

Effective annual interest rate = (1 + 0.0825/1)^1 - 1 = 8.25%

Interest paid over a year = $202,500 x 8.25% = $16,731.25

Finally, the stated APR can be calculated as:

Stated APR = (Interest paid over a year / Amount borrowed) x 100%

Stated APR = ($16,731.25 / $202,500) x 100% = 8.25% / (1 - 0.1)

Stated APR = 7.4%

Therefore, the answer is C.

Effective Interest Rate: Good Homes Furnishings Is Borrowing $225,000