Question

Question completion Status: Close Window Save and Submit > Click Submit to complete this assessment Question 25 of 25 Question 25 4 points Save Answer Porn Inc. needs to borrow $250,000 for the next 6 months. The company has a line of credit with a bank that allows the company to borrow funds with an interest rate subject to a zoolan compensating balance. Currently Penn Inc. has no funds on deposit with the bank and will need the loan to cover the compensabing balance as well as their other financing needs. What will be the annual percentage rate, or APR for the financing 8.75% 10.00% 125% 11.25% > Click Submit to complete this assessment Question 25 of 25 Close Window Save and Submit 10:45 PM Type here to search Ogoe og

Answer 1

The answer is option A [8.75%]

Explanation:

Since the bank has a condition to place 20% of borrowed funds as loan compensating balance, and as of now the company does not have any deposits with the bank, the company needs to borrow funds sufficient for both its financing needs as well as to maintain compensating balance with the bank

Funds for Financing Needs = $ 250,000

% of Funds needed to be maintained as compensating balance = 20%

Hence Amount to be borrowed from bank = $ 250,000/(100%-20%) = $ 312,500

The company now uses $ 250,000 for its financing needs and maintains $ 62,500 as compensating balance with the bank [since 20%* $ 312,500 = $ 62,500 which is satisfying the needs of the bank]

Now the annual interest company needs to pay on $ 312,500 = 7%* 312,500 = $ 21,875

Now this interest needs to be seen as paying only on $ 250,000 since the remaining $ 62,500 is just to be maintained as compensating balance.

Hence effective annual percentage rate APR = $ 21,875/$ 250,000 = 8.75%

[Note: Since we are calculating everything is terms of annual percentages and the question is also asked in terms of APR, we need not worry about how many months that the company is borrowing the funds for]