Logan Drilling Corp. Plans to borrow $200,000 for one year. Northern N

QUESTION

Logan Drilling Corp. Plans to borrow $200,000 for one year. Northern National Bank will lend the money at 10 percent interest and requires a compensating balance of 20 percent. What is the effective rate of interest?
According to the given information,Interest amount at 10% = 10% ($200,000) = $20,000The balance is compensated with 20% interest.The interest amount at 20% = 20% ($200,000) = $40,000Remaining balance after the compensation of 20% interest = $200,000 $40,000 = $160,000Since the balance is compensated at a higher interest

e, this leads to increase of the proceeds of the loan. As the proceeds increases, the effective interest rate decreases.Therefore, the effective interest rate is calculated as: EIR = $20,000 / $160,000 = 0.125 or 12.5%

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