Question

g On January 1, 2020, Lynn Company borrows $3,000,000 from National Bank at 11% annual interest. In addition, Lynn is required to keep a compensatory balance of $300,000 on deposit at National Bank which will earn interest at 5%. The effective interest that Lynn pays on its $3,000,000 loan is

Answer 1

Answer:

The effective interest that Lynn pays on its $3,000,000 loan is 11.67%

Explanation:

For computing the interest rate, first, we have to find out the effective interest which is shown below:

= Interest on borrowings - interest on the compensatory balance

where,

Interest on borrowings = Borrowings × interest rate

                                      = $3,000,000 × 11%

                                      = $330,000

Interest on compensatory balance = Compensatory balance  × interest rate

                                                          = $300,000 × 5%

                                                          = $15,000

Now put these values to the above formula  

So, the value would equal to

= $330,000 - $15,000

= $315,000

The formula to compute effective rate is shown below:

= Effective interest ÷ Total funds available

Where,

Total fund available = Borrowed amount - compensatory balance

                                = $3,000,000 - $300,000

                                = $2,700,000

And, the effective interest is $315,000

Now put these values to the above formula  

So, the rate would equal to

= $315,000 ÷ $2,700,000

= 11.67%