Question

Rockville Corporation is going to borrow $250,000 from its bank at an APR of 8.5 percent. The bank requires its customers to maintain a 10 percent compensating balance. What is the effective interest rate on this bank loan? Round to 4 decimal places and enter percentages as a decimal.

Answer 1

SOLUTION:-

Calculate of effective interest rate if Rockville corporation as follows:-

Here,

Amount borrowed = 250,000

Interest = 8.5%

Compensate balance = 10% on loan

Amount deposited as compensate balance = 250,000*10% = 25,000

Effective borrowing = 250,000 - 25,000 = 225,000

Interest expense = amount borrowed * interest rate

= 250,000*8.5

Interest expense = 21,250.

Effective interest rate = interest expense / effective borrowing amount

= 21,250/225,000

= 0.09444444

Effective interest rate = 9.4444%

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