What is the effective annual interest rate for a 1-year $100 million loan with a stated interest rate of 8.00%, if the lending bank requires a non-int... Accounting MCQs | Accounting MCQs

What is the effective annual interest rate for a 1-year $100 million loan with a stated interest rate of 8.00%, if the lending bank requires a non-interest bearing compensating balance in the amount of $5 million?

7.62%
8.00%
8.42%
13.00%Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

Answer (C) is correct. The bank requires a compensating balance of 5% ($5 million ÷ $100 million). The firm’s effective rate on this loan can be calculated as follows:
Effective rate = Stated rate ÷ (1.0 – compensating balance %)
= 8% ÷ (100% – 5%)
= 8% ÷ 95% = 8.42%
The amount of the loan is not needed to calculate the effective rate.