Formal line of credit: Storm Electronics has set up a formal line of credit of $2 million with First Kentucky Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 6.25 per cent on the loan, and in addition the company will pay an annual fee of 60 basis points on the unused balance. The company borrowed $1,500,000 on the first day the credit line became available. What is the company's effective interest rate on this line of credit? Round to two decimal places.

Question

Quizplus · Accepted Answer

To calculate the effective interest rate, we need to consider both the interest rate and the annual fee on the unused balance.

Interest expense on the borrowed amount:

= $1,500,000 * 6.25% = $93,750

Annual fee on the unused balance:

= ($2,000,000 - $1,500,000) * 0.006 = $3,000

Total cost of the line of credit:

= $93,750 + $3,000 = $96,750

Effective interest rate:

= Total cost / Amount borrowed * 100

= $96,750 / $1,500,000 * 100

= 6.45%

Therefore, the company's effective interest rate on this line of credit is 6.45%.

Formal Line of Credit: Storm Electronics Has Set Up a Formal