Question

Carey Company is borrowing $300,000 for one year at 11.0 percent from Second Intrastate Bank. The bank requires a 15 percent compensating balance. The principal refers to funds the firm can effectively utilize (Amount borrowed − Compensating balance).   
  
a. What is the effective rate of interest? (Use a 360-day year. Input your answer as a percent rounded to 2 decimal places.)
  

     

b. What would the effective rate be if Carey were required to make 12 equal monthly payments to retire the loan? (Use a 360-day year. Input your answer as a percent rounded to 2 decimal places.)
  

  

Answer 1

A: Interest for 1 year = 11%*300000 =$33,000

Funds available = Amount borrowed – compensating balance

= 300000-15%*300000

= $255,000

Effective rate of interest = 33000/255000 = 12.94%

B: First we compute the monthly payment

Using financial calculator

Input: PV = 300000 , I/Y = 11/12 ; N = 12

Solve for PMT as 26,514.50

Now we compute the effective rate

Using financial calculator

Input: PMT = 26,514.50 ; N=12 ; PV =300000*(1-0.15) = 255000

Solve for I/Y as 3.58

Effective rate = 3.58*12 = 42.97%