Carey Company is borrowing $200,000 for one year at 9.0 percent from Second Intrastate Bank. The...
Carey Company is borrowing $200,000 for one year at 9.0 percent
from Second Intrastate Bank. The bank requires a 20 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?
Homework Answers
(a) [Interest / (Principal – Compensating Balance)] X [Days in the year (360)/Days loan is outstanding]
Interest = $200000 * 9% = $18000
Compensating balance = $200000 * 20% = $40000
[$18000/($200000 - $40000)] X [360/360]
= 11.25%
(b) [2 * Annual No of Payments * Interest] / [(Total No of Payments + 1) * Principal]
[2 * 12 * $18000] / [12 + 1] * ($200000 - $40000)
$432000/$2080000
= 20.77%
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