Question

Ivanhoe, Inc., has just set up a formal line of credit of $10 million with First Community Commercial Bank. The line of credit is good for up to five years. The bank will charge Ivanhoe an interest rate of 7.00 percent on any amount borrowed, and the firm will pay an annual fee of 60 basis points on the unused balance. The firm borrowed $8.0 million on the first day the credit line became available. What is the effective interest rate on this line of credit? (Round answer to 2 decimal places, e.g. 12.25%.)

Answer 1

Ivanhoe, Inc., has set up a formal line of credit of $10 million with First Community Commercial Bank.

The firm borrowed $8.0 million on the first day the credit line became available.

There are two types of charges on this line of credit

• Bank’s interest on borrowed money
• Annual fees on unused balance

Let’s calculate both charges for Ivanhoe, Inc.,

• Bank’s interest on borrowed money = Bank interest rate * borrowed money

Where,

Bank interest rate = 7%

Borrowed money = $8 million or $8,000,000

Therefore,

Bank’s interest on borrowed money =7% * $8,000,000 = $560,000

• Annual fees on unused balance = (formal line of credit borrowed money) *Annual fees

Where,

Formal line of credit = $10 million

Borrowed money = $8 million

Annual fees = 60 basis point or 0.60%

Therefore,

Annual fees on unused balance = ($10 million - $8 million) * 0.60%

= $12,000

Total charges = Bank’s interest on borrowed money +Annual fees on unused balance

= $560,000 + $12,000 = $572,000

Therefore effective interest rate on this line of credit = (Total charges / Borrowed amount) *100

= ($572,000 / $8,000,000) *100

= 7.15%