Question

To ensure that, along with spontaneous financing from accounts payable and accruals, adequate short-term financing will be available, Morton plans to establish an unsecured short-term borrowing arrangement with its local bank, Third National. The bank has offered either a line-of-credit agreement or a revolving credit agreement. Third National's terms for a line of credit are an interest rate of 2.50% above the prime rate, and the borrowing must be reduced to zero for a 30-day period during the year. On an equivalent revolving credit agreement, the interest rate would be 3% above prime with a commitment fee of 0.50% on the average unused balance.
Under both loans, a compensating balance equal to 20% of the amount borrowed would be required. The prime rate is currently 7%. Both the line-of-credit agreement and the revolving credit agreement would have borrowing limits of $1,000,000. For purposes of his analysis, Morton estimates that Kanton will borrow $600,000 on the average during the year, regardless of which financing strategy and loan arrangement it chooses. (Note: assume a 365-day year.)

d. Find the effective annual rate under: 1) the line-of-credit agreement and 2) the revolving credit agreement. (Hint: Find the ratio of the dollars that the firm will pay in interest and commitment fees to the dollars that the firm will effectively have use of.)
e. If the firm expects to borrow an average of $600,000, which borrowing arrangement would you recommend to Kanton? Why?

Answer 1

Well, i have abesolutely no idea so .