Tangshan Mining borrowed $100,000 for one year under a revolving credit agreement that authorized and guaranteed the firm access to $200,000. The revolving credit agreement had a stated interest rate of 7.5 percent and charged the firm a 1 percent commitment fee on the unused portion of the agreement. Based on this information, the effective annual interest rate on the loan is ________.
A) 7.5%
B) 8.0%
C) 8.5%
D) 9.0%

Question

Quizplus · Accepted Answer

The effective annual interest rate on the loan would be higher than the stated interest rate of 7.5% due to the 1% commitment fee charged on the unused portion of the agreement. Since Tangshan Mining only borrowed $100,000 out of the authorized $200,000, they will be charged the commitment fee on the unused $100,000. 
So, the effective annual interest rate can be calculated as:
Effective Annual Interest Rate = (Stated Interest Rate + Commitment Fee)/(1 - Unused Portion of the Agreement)
Effective Annual Interest Rate = (7.5% + 1%)/(1 - 0.5)    (since unused portion is $100,000 out of authorized $200,000)
Effective Annual Interest Rate = 8.5%
Therefore, the best choice is C.

Tangshan Mining Borrowed $100,000 for One Year Under a Revolving