Trend, Inc. has just set up a formal line of credit of $5 million with First National Bank. The line of credit is good for up to three years. The bank will be charging them an interest rate of 7.5 percent on the loan, and in addition, the firm will pay an annual fee of 50 basis points on the unused balance. The firm borrowed $2,300,000 on the first day the credit line became available. What is the firm's effective interest rate on this line of credit? Round your final percentage answer to one decimal place.
A) 8.5%
B) 7.2%
C) 9.0%
D) 8.1%

Question

Quizplus · Accepted Answer

To calculate the effective interest rate, we need to take into account both the interest rate charged on the borrowed amount and the annual fee charged on the unused balance.

For the borrowed amount of $2,300,000, the interest charged in one year would be:

$2,300,000 x 0.075 = $172,500

For the unused balance, the annual fee charged would be:

$5,000,000 x 0.005 = $25,000

Therefore, the total cost of the line of credit in one year would be:

$172,500 + $25,000 = $197,500

To calculate the effective interest rate, we divide the total cost by the amount borrowed:

$197,500 / $2,300,000 = 0.0859 or 8.59%

Rounding to one decimal place, the answer is D) 8.1%.