ProblemChapter 223
Del Hawley, owner of Hawley’s Hardware, is negotiating with First City Bank for a 1year loan
of $50,000.
First City has offered Hawley the following alternatives.
Calculate the effective
annual interest rate for each alternative.
Which alternative has the lowest effective annual
interest rate?
a
.
A 12% annual rate on a simple interest loan with no compensating balance
required and interest due at the end of the year.
Interest paid = $50,000 x 12% = $6,000
With a financial calculator, (setting 1_p/yr) enter N = 1, PV = 50000, PMT = 6000, and
FV = 50000 to solve for I/YR = 12.00%.
Effective rate = (Interest paid/Amount received=6,000/50,000=12%)
NOTE: this equation only works for loans of one year.
b
.
A 9% annual rate on a simple interest loan, with a 20% compensating balances
required and interest due at the end of the year.
Compensating balance =$50,000 * 20% =10,000
0
1


50,000
50,000
 4,500
10,000
(compensating balance)
10,000
40,000
44,500
With a financial calculator, (setting 1_p/yr) enter N = 1, PV = 40000, PMT = 0, and