Wayne,Inc.has a line of credit with First National Bank that allows the company to borrow up to $800,000 at an interest rate of 12 percent.However,Wayne,Inc.must keep a compensating balance of 18 percent of any amount borrowed on deposit at the bank.Wayne,Inc.does not normally keep a cash balance account with First National Bank.What is the effective annual cost of credit?
A) 12.40%
B) 12.83%
C) 14.63%
D) 15.47%

Question

Quizplus · Accepted Answer

The effective annual cost of credit takes into account the interest rate and any fees or requirements, such as the compensating balance in this case. To calculate it, we need to find the interest paid on the borrowed amount ($800,000) and the cost of the compensating balance (18% of $800,000 = $144,000).

Interest paid = $800,000 x 0.12 = $96,000
Cost of compensating balance = $144,000 x 0.12 = $17,280

Total cost of credit = $96,000 + $17,280 = $113,280

To find the effective annual cost, we divide the total cost by the amount borrowed and multiply by 100 to get a percentage:

Effective annual cost = ($113,280 / $800,000) x 100 = 14.16%

Therefore, the best choice is C) 14.63%.

Wayne,IncHas a Line of Credit with First National Bank That