XXX Supplies borrows £1 million at 10 percent, payable in one year

Business Sep 16, 2020

XXX Supplies borrows £1 million at 10 percent, payable in one year. If XXX is required to maintain a compensating balance of 15 percent, what is the effective percentage cost of its loan (in pounds)?

Expert Solution

The amount of interest paid is 1,000,000X10%=100,000. The amount borrowed is 1,000,000 but the amount received after the compensating balance of 15% is 85% of 1,000,000=850,000. The interest of 100,000 is paid on the capital used of 850,000.
Effective percentage cost = 100,000/850,000=11.76%

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