# Cost of compensating balance: Suppose a firm has a $100,000 line of credit with 10% compensating... ## Question: Cost of compensating balance: Suppose a firm has a$100,000 line of credit with 10% compensating balance requirement Quoted interest on credit line = 16 % Firm needs \$54,000 to purchase inventory.

1.) How much does a firm actually need to borrow? (Answer is 60,000 but I need to know how to get it so please show work)

2.) What is the effective interest rate? (The answer is 17.8% but I do not know how to get it so please show work)

## Credit Line:

A credit line is a flexible borrowing arrangement, typically between a company and a bank, that allows the company to borrow funds whenever needed and repay them whenever convenient. The arrangement is similar to a credit card for an individual.

1)

The bank will keep 10% of the amount borrowed as a compensating balance. So:

• Amount needed = Amount borrowed * (1 - Compensating balance)
• 54,000...

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