Idaho Mining,Inc.borrows at prime plus 1.5% on its line of credit.The line requires a 15% compensating balance.If the prime rate is 9% and Idaho Mining plans on borrowing for a period of one year,what is the nominal APR of the line of credit?
A) 9.0%
B) 6.0%
C) 10.6%
D) 12.4%

Question

Quizplus · Accepted Answer

The nominal APR can be calculated by considering the interest rate (prime + 1.5%) and the effect of the compensating balance. The prime rate is 9%, so the interest rate on the line of credit is 9% + 1.5% = 10.5%. However, because of the 15% compensating balance, the effective amount available for use is reduced. To find the effective APR, we divide the interest rate by the portion of the loan available after accounting for the compensating balance: 10.5% / (1 - 0.15) = 10.5% / 0.85 = 12.35%, which rounds to 12.4%.