Question

On January 1, 2010, Lynn Company borrows $2,000,000 from National Bank at 11% annual interest. In addition, Lynn is required to keep a compensatory balance of $200,000 on deposit at National Bank which will earn interest at 5%.

The effective interest that Lynn pays on its $2,000,000 loan is:

a. 10.0%.
b. 11.0%.
c. 11.5%.
d. 11.6%.

Answer 1

effective interest rate = 11.6 %

so correct option is d. 11.6%

Step-by-step explanation:

given data

borrows = $2,000,000

annual interest = 11 %

compensatory balance = $200,000

earn interest = 5%

to find out

effective interest rate

solution

first we get here fund that is available for use that is

fund available for use is = borrows - compensatory balance ........1

fund available for use is = $2,000,000 - $200,000

fund available for use is = $1,800,000

and

interest at borrow @11% = $2,000,000 × 11%

interest at borrow @11% = $220,000

and

interest earn at @5% = $200,000 × 5%

interest earn at @5% = $10,000

so

effective interest paid is = $220,000 - $10,000

effective interest paid is = $210,000

and

now effective interest rate will be

effective interest rate =
`(effective\ interest\ paid)/(fund\ available\ for\ use)`

effective interest rate =
`(210,000)/(1,800,000 )`

effective interest rate = 11.6 %

so correct option is d. 11.6%