The Stuart Glass Company established a line of credit with a local bank.The maximum amount that can be borrowed under the terms of the agreement is $1,000,000 at an annual rate of 8 percent.A compensating balance averaging 25 percent of the amount borrowed is required.Prior to the agreement,Stuart had no deposit with the bank.Shortly after signing the agreement,Stuart needed $240,000 to pay off a note that was due.It borrowed the $240,000 from the bank by drawing on the line of credit.What is the effective annual cost of credit?
A) 12.50%
B) 11.11%
C) 10.67%
D) 8.85%

Question

Quizplus · Accepted Answer

The effective annual cost of credit is calculated as:
[(Interest paid + Compensating balance)/(Amount borrowed - Compensating balance)] x 100

Interest paid = Amount borrowed x Annual interest rate
= $240,000 x 8% = $19,200

Compensating balance = Average balance required x Percentage
= ($240,000 x 25%) / 12 = $5,000

Effective amount borrowed = Amount borrowed - Compensating balance
= $240,000 - $5,000 = $235,000

Therefore, the effective annual cost of credit is:
[(19,200 + 5,000)/(235,000)] x 100 = 10.67%

The Stuart Glass Company Established a Line of Credit with a Local