[khachik2003]

Wiley Question –

the question asks:

On January 1, Scott Corp received a $300,000 line of credit at an interest rate of 12% and drew down the entire amount on February 1. The LOE agreement requires that an amount equal to 15% of the loan be deposited into a compensating balance account. What is the effective annual cost of credit for this loan agreement?

a. 11%

b. 12%

c. 12.94%

d. 14.12%

I took calculated the interest cost for only 11 months because the loan was drawn on Feb 1 and got $33,000. Then I divided that by the total amount available for the loan, $255,000 (300,000 x 85%). I got 12.94% but the book says the answer is 14.12% because they used the entire interest cost amount for the whole year.

I understand how to do the problem but what I don’t understand is why we would use the interest cost for the entire year ($36,000) instead of only the interest for 11 months ($33,000), seeing as how the loan was drawn on February 1st.