Topka, Inc., needs to borrow $500,000 to meet its working capital requirements for next year. The Merchant Bank has offered the company a 9.5% simple ... Accounting MCQs | Accounting MCQs

Topka, Inc., needs to borrow $500,000 to meet its working capital requirements for next year. The Merchant Bank has offered the company a 9.5% simple interest loan that has a 16% compensating balance requirement. Determine the effective interest rate for the loan.

11.02%
11.31%
12.75%
19.00%Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

Answer (B) is correct. The effective interest rate is equal to the net interest expense over the usable funds. Topka’s net interest expense is equal to $47,500 ($500,000 × 9.5%). Because the bank is requiring a compensating balance of 16 , Topka’s usable funds are equal to $420,000 [$500,000 – ($500,000 × 16%)]. Thus, the effective interest rate is 11.31% ($47,500 ÷ $420,000 .