Answer (A) is correct . The $50,000 compensating balance requirement is partially satisfied by the company’s practice of maintaining a $25,000 balance for transaction purposes. Thus, only $25,000 of the loan will not be available for current use, leaving $225,000 of the loan usable. At 6% interest, the $250,000 loan would require an interest payment of $15,000 per year. This is partially offset by the 2% interest earned on the $25,000 incremental balance, or $500. Subtracting the $500 interest earned from the $15,000 of expense results in net interest expense of $14,500 for the use of $225,000 in funds. Dividing $14,500 by $225,000 produces an effective interest rate of 6.44%.
Answer (B) is incorrect because This percentage fails to consider that the $25,000 currently being maintained counts toward the compensating balance requirement.
Answer (C) is incorrect because This percentage fails to consider the compensating balance requirement.
Answer (D) is incorrect because This percentage fails to consider the interest earned on the incremental balance being carried.
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