Question

Digital Access Inc. needs \(400,000 in funds for a project.

a. With a compensating balance requirement of 20 percent, how much will the firm need to borrow?

b. Given your answer to part a and a stated interest rate of 9 percent on the total amount borrowed, what is the effective rate on the \)400,000 actually being used?

Short answer

The firm needs to borrow is $500,000.

Step-by-step solution

Information provided in the question

Amount needed = $400,000

Compensating balance = 20%

Calculation of funds required

The firm needs to borrow is $500,000.

$\begin{array}{rcl}\mathrm{Amount}\mathrm{to}\mathrm{be}\mathrm{borrowed}& =& \frac{\mathrm{Amount}\mathrm{needed}}{1-\mathrm{Compensating}\mathrm{balance}}\\ & =& \frac{\$400,000}{1-20\%}\\ & =& \frac{\$400,000}{0.80}\\ & =& \$500,000\end{array}$