Question

maxim air filters inc. plans to borrow $300,000 for one year. northeast national bank will lend the money at 10 percent interest and requires a compensating balance of 20 percent. what is the annual rate of interest? (use 365 days in a year. round your answer to 2 decimal places.) annual rate of interest

Answer 1

The effective annual rate of interest Maxim Air Filters Inc. is paying on the loan, considering the compensating balance requirement, is 12.5%.

Step-by-step explanation:

Maxim Air Filters Inc. plans to borrow $300,000 for one year from Northeast National Bank at an interest rate of 10% with a compensating balance requirement of 20%. To find the annual rate of interest, we need to consider the effective amount of the loan that Maxim Air Filters will be able to use, after accounting for the compensating balance.

The compensating balance requirement means that 20% of the loan amount will not be available for the company's use. So, 20% of $300,000 is $60,000, which will be held by the bank. Maxim can use only $240,000 ($300,000 - $60,000). However, the company still pays interest on the entire $300,000 loan. The interest for one year would be 10% of $300,000, which is $30,000.

To find the annual interest rate, we divide the annual interest by the effective loan amount: $30,000 / $240,000 = 0.125 or 12.5%. Hence, the effective annual rate of interest Maxim is paying is 12.5%.