AIE Industries plans to purchase a new delivery truck for $250,000. The company has been quoted an annual rate of 6.5 percent with discount interest and a compensating balance of 2 percent.
a. How much will AIE have to borrow?
b. What is the effective rate on this loan?

c. If AIE can convince the bank to remove the compensating balance requirement, what is the effective rate?

a. AIE will have to borrow $25,5102.04  

b. The Effective Rate on this Loan is 6.63%

c. If AIE can convince the bank to remove the compensating balance requirement the  effective rate is 6.50%

Explanation:

In order to calculate how much will AIE have to borrow we would have to use the following formula:

Amount to be borrowed = Cost of Truck / (1 - Compensating balance)

Amount to be borrowed = $250000 / (1 - 0.02)

a. Amount to be borrowed = $25,5102.04

In order to calculate the effective rate on this loan we calculate the following:

Effective Rate on this Loan = Interest / Amount received

Effective Rate on this Loan = 16581.63 / 250000

b.  Effective Rate on this Loan = 6.63%

c. If AIE can convince the bank to remove the compensating balance requirement the Effective rate = annual rate, hence the effective rate is 6.50%

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