[Biff-1955-Tannen]

The answer is D, and uses numerator of 36,000. I used $33,000 since they drew down on Feb 1st… Is their answer correct? Seems odd to pay interest on a line of credit you’re not using. Everybody has a line of credit on their credit card and only pays interest on the amount they use…

On January 1, Scott Corporation received a $300,000

line of credit at an interest rate of 12% from Main Street Bank

and drew down the entire amount on February 1. The line of

credit 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 arrangement?

a. 11.00%

b. 12.00%

c. 12.94%

d. 14.12%

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[Anonymous]

Annual cost of credit would be the cost to have it out for the whole year (like a credit card APR is the rate you'd pay if you kept the money all year long), so I think this is one of those where they threw in the Feb 1 draw-down just to try to throw you off. They didn't say “It was kept till Dec 31 Year 1, what did this effectively cost the company in Year 1?”, they said “What's the annual cost of credit”, which is like “what's the APR”, not “what did they pay in interest this year”/

[Biff-1955-Tannen]

Ahhh ok that makes sense then. Another trick question, what do ya know.

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[Anonymous]

I didn't know how they arrived at the answer either but thank god for Google. See below and the link to the website as well.

The effective interest rate on this financing arrangement can be calculated as follows: Effective rate = Stated rate ÷ (1.0 – Compensating balance %) = 12% ÷ (100% – 15 = 12% ÷ 85% = 14.12% The amount of the loan is not needed to calculate the effective rate.

https://www.accountingask.com/on-january-1-scott-corporation-received-a-300000-l-mcq-2151

[FIFOisbetterthanLIFO]

Generally, line of credits have a regular interest rate for money you have borrowed, and then an unused line fee for the portion you are not borrowing. For instance, I've seen the regular interest rate be 5% and the unused line fee .05%. Usually, it isn't a huge penalty, but the lender wants to encourage you to use the line.

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BEC - Passed (76)
AUD - Passed (89)
REG - Passed! (81)
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[Author]

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