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14. Holland Construction Co. has an outstanding 180-day bank loan of $400,000 at an annualinterest rate of 9.5%. The company is required to maintain a 15% compensating balance in itschequing account. What is the annual interest cost on the loan? Assume the company wouldnot normally maintain this average amount.A. 11.18%

Question

  1. Holland Construction Co. has an outstanding 180-day bank loan of $400,000 at an annualinterest rate of 9.5%. The company is required to maintain a 15% compensating balance in itschequing account. What is the annual interest cost on the loan? Assume the company wouldnot normally maintain this average amount.A. 11.18%
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Solution

To calculate the annual interest cost on the loan, we need to follow these steps:

  1. Calculate the interest on the loan: The interest on the loan can be calculated using the formula: Interest = Principal x Rate x Time. Here, the principal is 400,000,therateis9.5400,000, the rate is 9.5% (or 0.095 when expressed as a decimal), and the time is 180/365 (since the loan is for 180 days and there are 365 days in a year). So, the interest on the loan is 400,000 x 0.095 x (180/365) = $18,630.14.

  2. Calculate the compensating balance: The compensating balance is 15% of the loan amount, which is 400,000x0.15=400,000 x 0.15 = 60,000. This is the amount the company is required to maintain in its checking account.

  3. Adjust the loan amount: The effective loan amount is the total loan minus the compensating balance. So, the effective loan amount is 400,000−400,000 - 60,000 = $340,000.

  4. Calculate the annual interest cost: The annual interest cost is the interest on the loan divided by the effective loan amount, expressed as a percentage. So, the annual interest cost is (18,630.14/18,630.14 / 340,000) x 100 = 5.48%.

So, the annual interest cost on the loan, taking into account the required compensating balance, is 5.48%.

This problem has been solved

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