You’ve worked out a line of credit arrangement that allows you to borrow up to $
ID: 2761736 • Letter: Y
Question
You’ve worked out a line of credit arrangement that allows you to borrow up to $60 million at any time. The interest rate is .578 percent per month. In addition, 4 percent of the amount that you borrow must be deposited in a noninterest-bearing account. Assume that your bank uses compound interest on its line-of-credit loans.
What is the effective annual interest rate on this lending arrangement? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Suppose you need $19.2 million today and you repay it in six months. How much interest will you pay?(Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).)
You’ve worked out a line of credit arrangement that allows you to borrow up to $60 million at any time. The interest rate is .578 percent per month. In addition, 4 percent of the amount that you borrow must be deposited in a noninterest-bearing account. Assume that your bank uses compound interest on its line-of-credit loans.
Explanation / Answer
Solution:
(a)
Calculation of Effective Annual Interest Rate
Effective Annual Interest Rate = (1 + R)n– 1
R = Normal rate of interest for the period interest compounded = 0.00578 per month
N = number of times interest compounded in a year = 12 times in a year
Effective Annual Interest Rate = (1 + 0.00578)12– 1 = 1.07160799 – 1 = 0.071607 or 7.16% per annum
(b)
Borrowed Amount = $19,200,000
Rate of Interest = 0.578% per month
Borrowing Period = 6 Months
Total Interest Paid = Borrowed Amount x (1 + R)n - Borrowed Amount
= $19,200,000 x (1 + 0.00578)6 - $19,200,000
= $19,875,552 - $19,200,000 = $675,552
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