Pacific Automotive has a $250,000 compensating balance loan with its bank.The terms of the loan call for Pacific to keep 10% of the loan as a compensating balance and pay interest at an annual rate of 6.50% on the entire amount.If the firm borrows the maximum amount for one year,what is the EAR on this loan?

Question

Quizplus · Accepted Answer

To calculate EAR, we need to take into account the effect of the compensating balance.

The amount of loan Pacific can receive is:
Loan amount = $250,000 / (1-0.10) = $277,778.

The interest payment for one year is:
Interest payment = $277,778 x 0.065 = $18,056.

So the effective loan amount is:
Effective loan amount = $277,778 - $18,056 = $259,722.

Therefore, the EAR is:
EAR = (1 + 0.065/0.9)^0.9 - 1 = 0.0722 or 7.22%.

Therefore, the answer is (C).

Pacific Automotive Has a $250,000 Compensating Balance Loan with Its