A firm has 900000 in inventory qualifying for a shortterm lo

A firm has $900,000 in inventory qualifying for a short-term loan with a warehouse receipt. A commercial bank will accept this warehousing agreement and inventory as collateral and will advance 80% of the value of the inventory on loan at 6%. The bank charges $5,000 upfront for the agreement. The firm will use the borrowing for 60 days. What is the effective annual rate on the borrowing?

Solution

LOAN GRANTED = 80% OF 900000 = 720000

INTEREST PAYABLE = 6% X 720000 X (60/365) = 7101.37

AS UPFRONT AGREEMENT, 5000 PAYABLE TODAY SO LOAN AVAILABLE IS 720000-5000 = 715000

INTEREST RATE FOR 60 DAYS = 7101.37/715000 * 100 = 0.994%  

THEREFORE EFFECTIVE RATE OF INTEREST = (1+0.00994)^(365/60) - 1 = 6.20%

ANSWER = 6.20%