Dr. Ruth is going to borrow $5,700 to help write a book. The loan is for one yea

Question

Dr. Ruth is going to borrow $5,700 to help write a book. The loan is for one year and the money can either be borrowed at the prime rate or the LIBOR rate. Assume the prime rate is 12 percent and LIBOR 2.5 percent less. Also assume there will be a $41 transaction fee with LIBOR (this amount must be added to the interest cost with LIBOR).

What is the effective interest rate on the LIBOR loan? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Which loan has the lower effective interest cost?

Dr. Ruth is going to borrow $5,700 to help write a book. The loan is for one year and the money can either be borrowed at the prime rate or the LIBOR rate. Assume the prime rate is 12 percent and LIBOR 2.5 percent less. Also assume there will be a $41 transaction fee with LIBOR (this amount must be added to the interest cost with LIBOR).

Explanation / Answer

(i) Prime Interest Rate = 12 %

LIBOR Interest Rate = 12 - 2.5% = 9.5%

Interest on Loan of 5,700 at LIBOR rate = 5,700 X 9.5/100 = 541.50 $

Additional Charges for LIBOR Loan = 41 $

Total Interest Cost (assuming loan from LIBOR is taken) = 541.5 + 41 = 582.50 $

Effective Interest Rate considering LIBOR = 582.50/5,700 X 100 = 10.21 %

b. LIBOR has lower effective interest cost, since although the rate goes up by 0.61%, yet is lower than the prime rate by 1.79%

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