Pipeline Pharmaceuticals has a one-year $2 million line of credit at an interest rate of 5% (EAR).The loan has a loan origination fee of 2%.What is the actual interest rate paid?

Question

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The actual interest rate paid can be calculated by considering both the interest on the loan and the loan origination fee. The interest for one year is 5% of $2 million, which is $100,000. The loan origination fee is 2% of $2 million, which is $40,000. Therefore, the total cost of the loan is $140,000 ($100,000 + $40,000). To find the actual interest rate paid, divide the total cost of the loan by the loan amount and then multiply by 100 to convert to a percentage: ($140,000 / $2,000,000) * 100 = 7%. However, this calculation does not account for the fact that the origination fee reduces the actual amount of money available from the loan. The effective interest rate considering the reduced loan amount due to the upfront fee is higher, which is correctly calculated as 7.14% when considering the effective annual rate formula and the impact of upfront fees on the available loan amount.

Pipeline Pharmaceuticals Has a One-Year $2 Million Line of Credit