1 Calculate the effective interest cost on a 1000 line of cr

1. Calculate the effective interest cost on a $1,000 line of credit with a 6% stated interest rate and a 8% compensating balance.

a) 6.00%

b) 6.25%

c) 6.52%

d) 8.00%

2. A firm sells its receivables of $1,000 to a bank for $920. The average collection period is six months.   What is the effective annual rate?

a) 5.52%

b) 9.08%

c) 18.16%

d) 23.68%

3. Given that sales are forecasted to increases by 10%, which of the following is least likely to occur?

a) Long-term bonds should also increase by 10%

b) Cost of goods sold should also increase by 10%

c) Current assets should also increase by 10%

d) Current liabilities should also increase by 10%

Solution

1.

Amount of credit = $1,000

Compensating balance = $1,000 * 8% = $80

Net credit amount received = $1,000 - $80 = $920

Annual interest amount = $1,000 * 6% = $60

Effective interest cost = Annual interest amount/Net credit amount received

Effective interest cost = $60/$920 = 0.0652 = 6.52%

Hence, correct answer is C) 6.52%

2.

Cost of selling the receivables for six months = $1,000 - $920 = $80

Half yearly rate = $80/$920 = 0.0870 = 8.70%

Effective annual rate = 1.087² – 1 = 0.1816 = 18.16%

Hence, correct answer is c) 18.16%

3.

Correct answer is a) Long-term bonds should also increase by 10%

The increase in sales shall directly increase the current assets and current liabilities in the same proportion. Long term liabilities shall not be effected by increase in sales.