Question

Golden Foods, Inc. has a revolving credit agreement with its bank under which it can borrow up to $10 million at an annual interest rate of 10%. The firm is required to maintain a 20% compensating balance on any funds borrowed under this agreement and to pay a 1% commitment fee on the unused portion of the credit line. (Assume Golden has no existing funds on deposit with the bank.) Determine the EAR assuming an average of $6 million is outstanding on the credit line during the year.

Group of answer choices

13.3%

10.7%

10.0%

12.5%

Please solve the question correctly.

Answer 1

Option B is Right 10.7%

Workings:

Particular's	Amount
Credit line granted by bank	$10,000,000
Outstanding on Credit line	$6,000,000
Unutilised Limit ($10,000,000 - $6,000,000)	$4,000,000
Interest on Outstanding amount ($6,000,000 * 10%)	$600,000
Commitmenet fees ($4,000,000 * 1%)	$40,000
Effective Annual Interest rate (EAR) { ($600,000 + $40,000) / 6,000,000 } * 100	10.7%