Answer (C) is correct . The firm’s effective rate on this loan can be calculated as follows: Effective rate?= Stated rate ÷ (1.0 – compensating balance %) ?= 7% ÷ (100% – 20%) ?= 7% ÷ 80% ?= 8.75% The amount of the loan is not needed to calculate the effective rate.
Answer (A) is incorrect because The rate of 7.0% results from failing to consider the effect of the compensating balance.
Answer (B) is incorrect because The rate of 8.4% assumes a compensating balance percentage of 16.7%.
Answer (D) is incorrect because The rate of 13.0% results from subtracting the stated rate from the compensating balance rate.
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