Question

Huskie Toys has been offered a $12 million loan with a 7.5% rate. The loan is to be repaid with a single payment in three years. The loan requires a compensating balance of 20%, which will be held in an account paying 2% interest. The compensating balance and the interest it generates must be maintained in the account for the 3-year life of the loan. What annual rate does the loan charge?

Answer 1

Loan	12000000
Less : Compensating Balance	2400000
Net Inflow	9600000
Interest paid at end of year 1,2,3	900000
Interest Received at end of year 1,2,3	48000
Net Interest Paid for the period	852000

The actual rate of Interest is the rate which will equate the net cash outflows at the end of the various periods to the net amount borrowed.
i.e the r which satisfies the below equation is the rate of interest :

$9600000 = 852000/(1+r) + 852000/(1+r)^2 + 852000/(1+r)^3 + 9600000/(1+r)^3

Solving the above equation, we get r= 8.875%.

Ans : The annual rate of interest that the loan is actually charging is 8.875%

answered by: anonymous