Maxim Air Filters Inc. plans to borrow $267,000 for one year. Northeast National Bank will lend...

Question:

Maxim Air Filters Inc. plans to borrow $267,000 for one year. Northeast National Bank will lend the money at 14 percent interest and requires a compensating balance of 27 percent. What is the effective rate of interest? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Compensating Balance:

A compensating balance is the amount of fund that must be remained at a non-interest bearing account. For a loan with a compensating balance, the amount of fund available to the borrower is effectively reduced.

Answer and Explanation:

We can use the following formula to compute the effective rate of interest:

  • effective rate of interest = stated interest rate / (1 - compensating balance)
  • effective rate of interest = 14% / (1 - 27%)
  • effective rate of interest = 19.18%

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What Is a Bank Loan?

from Financial Accounting: Help and Review

Chapter 1 / Lesson 20
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