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 was
A) 7.5%.
B) 8.0%.
C) 8.5%.
D) 9.0%.

Question

Quizplus · Accepted Answer

The effective annual interest rate can be calculated using the following formula: 
Effective Annual Interest Rate = (1 + Stated Interest Rate / N) ^ N - 1 
Where N is the number of compounding periods per year. 
In this case, the stated interest rate is 7.5% and there is only one compounding period in a year.

So, the effective annual interest rate = (1 + 7.5% / 1) ^ 1 - 1 = 8.06%

In addition, the commitment fee is 1% on the unused portion of the agreement, which is $100,000 since Tangshan Mining borrowed $100,000. So the commitment fee is $1,000.

Therefore, the total cost of the loan for one year is: 
Interest + Commitment Fee = $100,000 x 7.5% + $1,000 = $8,000

The effective annual interest rate is calculated based on the total cost of the loan, so: 
Effective Annual Interest Rate = $8,000 / $100,000 = 8%

Thus the answer is 8.5% which is the closest choice to the calculated effective annual interest rate of 8%.

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