DAS,Inc.has a line of credit with FBT Bank that allows DAS to borrow up to $400,000 at an annual interest rate of 11 percent.However,DAS must keep a compensating balance of 25 percent of any amount borrowed on deposit at the bank.DAS does not normally have a cash balance account with the bank.What is the effective annual cost of credit?
A) 11.45%
B) 12.59%
C) 14.67%
D) 16.00%

Question

Quizplus · Accepted Answer

The effective annual cost of credit (EACC) is the true cost of borrowing money, taking into account any additional fees or conditions. In this case, DAS must keep a compensating balance of 25% of any amount borrowed on deposit at the bank, which means that they cannot use the full amount of the line of credit.

To calculate the EACC, we need to take into account both the interest rate and the value of the compensating balance:

Effective Annual Interest Rate = (1 + Interest rate/Compensating balance percentage) ^ (365/Number of days loan is outstanding) -1

= (1+0.11/0.25)^(365/365) -1

= 1.44 -1 = 0.44 or 44%

Therefore, the effective annual cost of credit is 14.67% (11% interest rate + 44% compensating balance), which is option C.

DAS,IncHas a Line of Credit with FBT Bank That Allows