Your firm is considering the following three alternative bank loans for $1,000,000:

A) 10 percent loan paid at year end with no compensating balance.

B) 9 % laon paid at year end with a 20% compesating balance.

C)6% loan that is discounted with a 20% compensating balance.

We were given hints to solve each problem which I have. the next question is the one I need help with.

Assume that you would normally not carry any bank balance that would meet the 20% compensating balance requirement. WHat is the rate of annual interest on each loan?

To determine the rate of annual interest on each loan, we need to adjust for the impact of the compensating balance requirement.

Loan A:
The given hint states that there is no compensating balance requirement for Loan A. Therefore, the loan amount of $1,000,000 is the actual amount that the firm will receive. The interest rate for Loan A is 10%.

Loan B:
The given hint mentions that a compensating balance of 20% is required for Loan B. This means that the firm must maintain a bank balance equal to 20% of the loan amount throughout the loan period. Since the loan amount is $1,000,000 and 20% of this is $200,000, the firm must keep $200,000 as a compensating balance, leaving them with only $800,000 to use. Therefore, the actual loan amount is $800,000, and the interest rate for Loan B is 9%.

Loan C:
The hint states that Loan C is discounted with a 20% compensating balance. This means that the bank will reduce the loan amount by 20% at the time of disbursal, and the firm will receive only 80% of the loan amount. In this case, if the loan amount is $1,000,000, then the firm will receive $800,000 (80% of $1,000,000) after the 20% discount. Therefore, the actual loan amount is $800,000, and the interest rate for Loan C is 6%.

To summarize:
- Loan A: 10% (No compensating balance).
- Loan B: 9% (Compensating balance of 20%, resulting in an actual loan amount of $800,000).
- Loan C: 6% (Compensating balance of 20%, resulting in an actual loan amount of $800,000).

Please note that the interest rates provided here are based on the given information and assumptions.