Leage Tronton Company has a $5 million revolving credit agreement with Bank of Danamon. Being a favored customer, the rate is set at 1 percent over the bank’s cost of funds, where the cost of funds is approximated as the rate on negotiable certificates of deposit (CDs). In addition, there is a 1⁄2 percent commitment fee on the unused portion of the revolving credit. If the CD rate is expected to average 9 percent for the coming year and if the company expects to utilize, on average, 60 percent of the total commitment, what is the expected annual dollar cost of this credit arrangement? What is the percentage cost when both the interest rate and the commitment fee paid are considered? What happens to the percentage cost if, on average, only 20 percent of the total commitment is utilized ?

Community Answer

Amount of revolving credit limit= $5 MillionInterest rate= 1% above CD rate.Given, expected average CD rate=9%.Therefore, interest rate applicable= 9% + 1% = 10%Scenario 1: Expected average utilization=60%.Therefore, interest on utilized credit limit= $5 million*60%*10%= $300,000Rate of commitment fee on unutilized portion= 0.5%Amount of commitment fee on unutilized portion= $5million*(1-60%)*0.5% = $10,000Therefore, total Dollar cost= Interest onutilized portion + commitment fee on unutilized portion=$300,000 + $10,000 = $310,000Pe ... See the full answer