A company has a $10,000 line of credit with a bank. The line of credit calls for an interest rate of 10 percent and a compensating balance of 5 percent. This firm needs $5,000 to pay for the inventory. a) How much does the firm need to borrow from the bank? b) What is the effective interest rate if the firm uses this line of credit with the compensating balance?

Answer and Explanation:

The computation is shown below:

1. Borrowed amount needed from the bank is shown below:

= Needed to pay amount ÷ 1 - compensating balance percentage

= $5,000 ÷ 0.95

= $5,263.18

b. The effective interest rate with the compensating balance is shown below is

= $5,263.18 × 10% ÷ $5,000 × 100

= $526  ÷ $5,000 × 100

= 10.53%

We simply do the above calculations for both parts so that the accurate amount and correct rate could come

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