Assume that the amount that you have to actually borrow for your ski and bike rental business mentioned in the previous question is $18,000. If it is still a one year loan and the bank will charge 4% discount interest and require a 10% compensating balance, then determine the effective annual interest rate that the bank is charging.

4.65%

Explanation:

Data provided in the question:

Amount borrowed = $18,000

Discount Interest rate = 4% = 0.04

Required compensating balance = 10%

Now,

Effective loan rate on Discount Loan with compensating balance is given as

⇒ [ (Interest rate) : (1 - interest %-Compensating balance%) ] * 100%

⇒ [ 4% : (1 - 4% - 10%) ] * 100%

⇒ [ 0.04 : (1 - 0.04 - 0.10) ] * 100%

⇒ [ 0.04 : 0.86 ] * 100%

⇒ 4.65%