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We have a $500,000 line of credit with a 10% compensating balance. The quoted interest rate is 4.5%. We need $200,000 for inventory for one year. What is the effective interest rate we are paying on this credit line

Sagot :

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Answer:

5.0%

Explanation:

Calculation to determine the effective interest rate we are paying on this credit line

First step is to calculate cost of inventory we need

Inventory=$200,000/(1 - 0.10)

Inventory=$222,222

Second step is to calculate Interest paid

Interest paid = $222,222(.045)

Interest paid= $9,999.99

Interest paid=$10,000 (Approximately)

Now let calculate the Effective rate

Effective rate =$10,000/$200,000

Effective rate= 0.05*100

Effective rate=5.0%

Therefore the effective interest rate we are paying on this credit line is 5.0%

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