A firm has agreed to borrow 750000 at a simple interest rate

A firm has agreed to borrow $750,000 at a simple interest rate of 6% for 30 days to meet its short-term funding needs. The bank charges a loan processing fee of $1,000. What is the effective annual rate on this loan?

Solution

EAR is calculated by taking total cost of the loan on effective time scale.

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Time = 30/365

Effective Annual Rate = ((Processing fees + Interest rate x Loan value x Time)/Loan value) x (1/time)

Effective Annual Rate = ((1000 + 6% x 750000 x 30/365)/750000) x (365/30)

Effective Annual Rate = 7.6%