Question

Randal Corporation plans to borrow $271,000 for one year at 15 percent from the Waco State Bank. There is a 25 pércent compensating balance requirement. Randall Corporation keeps minimum transaction balances of $12.500 in the normal course of business. This idle cash counts toward meeting the compensating balance requirement What is the effective rate of interest? (Use a 360-day year. Input your answer as a percent rounded to 2 decimal places.) Effective rate of interest

Answer 1

The idea of compensating balance is to keep the minimum balance with the bank.

Compensating amount from the loan = (Borrowing amount × Rate of compensating balance) – Idle cash

                                    = (271,000 × 25%) – 12,500

                                    = 67,750 – 12,500

                                    = 55,250

Actual loan amount = Borrowing amount – Compensating amount from the loan

                                    = 271,000 – 55,250

                                    = 215,750

Interest for the year = Borrowing amount × 15%

                                    = 271,000 × 15%

                                    = 40,650

Effective rate = (Interest for the year / Actual loan amount) × (360 / 365) × 100

                        = (40,650 / 215,750) × (360 / 365) × 100

                        = (40,650 × 360 × 100) / (215,750 × 365)

                        = (14,634,000 × 100) / 78,748,750

                        = 18.58%

Answer: 18.58