Charlton Enterprises negotiated a line of credit at the bank that requires it to pay 12.5% interest on its borrowing. The firm is required to maintain a compensating balance equal to 10% of the amount borrowed. The firm borrowed $500,000 during the year.
a. Calculate the effective annual rate on the firm’s borrowing if the firm normally maintains no deposit balances at the bank.
b. Calculate the effective annual rate on the firm’s borrowing if the firm normally maintains a deposit balance of $45,000 at the bank.
c. Calculate the effective annual rate on the firm’s borrowing if the firm normally maintains a deposit balance of $145,000 at the bank.
d. What is the change in the effective annual rate when the deposit balances increase?