Question

Assume that the amount that you have to actually borrow for your ski and bike rental business mentioned in the previous question is $18,000. If it is still a one year loan and the bank will charge 4% discount interest and require a 10% compensating balance, then determine the effective annual interest rate that the bank is charging.

Answer 1

Answer:

4.65%

Explanation:

Data provided in the question:

Amount borrowed = $18,000

Discount Interest rate = 4%  = 0.04

Required compensating balance = 10%

Now,

Effective loan rate on Discount Loan with compensating balance is given as

⇒ [ ( Interest rate ) ÷ (1- interest %-Compensating balance%) ] × 100%

⇒ [ 4% ÷ ( 1 - 4% - 10%) ] × 100%

⇒ [ 0.04 ÷ ( 1 - 0.04 - 0.10 ) ] × 100%

⇒ [ 0.04 ÷ 0.86 ] × 100%

⇒ 4.65%