As treasurer of your firm, you wish to establish a credit line facility to cover an expected average annual borrowing of $10 million. Bank of the West proposes a nominal rate of 6 percent on a credit line of $30 million, a commitment fee of 25 basis points on the unused portion of the credit line and a 35 percent compensating balance on the amount borrowed. What is the effective cost of borrowing? a. 10%
b. 9.62%
c. 16.92%
d. 13.08%

a. 10%

Explanation:

Interest cost at 6% = 10,000,000 * 6%

Interest cost at 6% = 600,000

Unused balance = 30,000,000 - 10,000,000

Unused balance = 20,000,000

Commitment fee at 0.25% = 20,000,000 * 0.25%

Commitment fee at 0.25% = 50,000

Compensating balance at 35% = 10,000,000 * 35%

Compensating balance at 35% = 3,500,000

Usable amount = 10,000,000 - 3,500,000

Usable amount = 6,500,000

So, Cost of borrowing = (600,000 + 50,000) / 6,500,000

Cost of borrowing = 650,000 / 6,500,000

Cost of borrowing = 0.1

Cost of borrowing = 10%

So, the effective cost of borrowing is 10%

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