Question

Problem 15-7 (similar to) ​(Cost of​ short-term financing​) You plan to borrow ​$30 comma 000 from the bank to pay for inventories for a gift shop you have just opened. The bank offers to lend you the money at 11 percent annual interest for the 6 months the funds will be needed. a. Calculate the effective rate of interest on the loan. b. In​ addition, the bank requires you to maintain a compensating balance of 18 percent in the bank. Because you are just opening your​ business, you do not have a demand deposit account at the bank that can be used to meet the​ compensating-balance requirement. This means that you will have to put up 18 percent of the loan amount from your own personal money​ (which you had planned to use to help finance the​ business) in a checking account. What is the cost of the loan​ now? c. In addition to the​ compensating-balance requirement in part ​(b​), you are told that interest will be discounted. What is the effective rate of interest on the loan​ now? a. What is the effective rate of​ interest, or APR​, on the​ loan

Answer 1

a	Effective rate of interest = Annual interest rate x (No. of months loan/12 months)
	= 11% x 6/12
	= 5.5%
b	Loan amount	$30,000
	Compensating balance (30000 x 18%)	$5,400
	Available Principle	$24,600
	Interest on loan (30000 x 5.5%)	$1,650
	Cost of the loan (1650/24600)	6.71%
	If interest will be discounted
	Loan amount	$30,000
	Compensating balance (30000 x 18%)	$5,400
	Interest on loan (30000 x 5.5%)	$1,650
	Available Principle (30000-5400-1650)	$22,950
	Effective rate	7.19%