A company’s bank requires a compensating balance of 20% on a $100,000 loan. If the stated interest on the loan is 7%, what is the effective cost of the loan?

To calculate the effective cost of the loan, we need to consider the compensating balance requirement.

Step 1: Calculate the compensating balance amount The compensating balance is 20% of the loan amount, which is $100,000. Compensating balance = 20$100,000 = $20,000

Step 2: Calculate the actual loan amount The actual loan amount is the loan amount minus the compensating balance. Actual loan amount = $100,000 -$20,000 = $80,000

Step 3: Calculate the interest paid on the loan The interest on the loan is stated as 7%. To calculate the interest paid, we multiply the actual loan amount by the interest rate. Interest paid = 7% * $80,000 =$5,600

Step 4: Calculate the effective cost of the loan The effective cost of the loan is the interest paid divided by the actual loan amount. Effective cost of the loan = $5,600 /$80,000 = 0.07 or 7%

Therefore, the effective cost of the loan is 7%.