Question

Charles & Garrett Associates arranged a $9 million revolving credit agreement with a group of banks. The firm must pay an annual commitment fee of 0.5% on the unused balance of the loan commitment. On the used portion of the revolver, it must pay 1.5% above the prime rate. The prime rate is expected to be 9% over the year. The firm faces a compensating balance requirement of 10% and its normal deposit balance is zero. If the firm borrows $6 million immediately once the revolver is signed, and repays at the end of one year, what is the AFC of the revolver?

Answer 1

Revolving Credit = $ 9,000,000 | Commitment Fee = 0.5% | Finance Cost on Borrowing = Prime Rate + 1.5%

Prime rate over the year = 9%

Borrowing cost = 9% + 1.5% = 10.5%

Borrowing = 6,000,000

Cost on borrowing = 6,000,000 * 10.5% = 630,000

Unused portion = 9,000,000 - 6,000,000 = 3,000,000

Commitment fee on unused portion = 3,000,000 * 0.5% = 15,000

Total Finance cost at the end of the year = 630,000 + 15,000 = 645,000

Annual Finance Cost = Total Finance cost in Dollars / Amount Borrowed = 645,000 / 6,000,000 = 10.75%

Hence, the AFC of the revolver is 10.75%