4. You recently approached your bank about establishing a credit line facility.

Question

4. You recently approached your bank about establishing a credit line facility. The terms offered by your bank include a nominal rate of prime + 1.5% (prime is currently 5%) on the amount borrowed, a commitment fee of 25 basis points on the unused portion of the credit line, and a compensating balance of 10% on the amount borrowed. You decide to establish the line for $75 million. Over the course of a year, you anticipate the average amount borrowed to be $55 million. Your firm keeps no balances at the bank paying fees for all cash management services. a. Estimate the cost of credit line. b. Assume that the firm did have cash balances to cover the required compensating balances resulting from the credit line borrowings. Estimate the effective cost of the credit line.

Explanation / Answer

$ millions Nominal rate on Borrowed                                                    55 @ 6.50% Commitment Fee on Unused portion 20 @ 0.25% Compensating Balance on Borrowed 55 @ 10.00% 1 Cost Of Credit Line Facility (55*6.5%) + (20*0.25%) $ 3.625 million ($ 3.625 + $ 5.5 ) million required to satisfy the terms of credit facility 2 Only amount of $ 3.625 million required to pay off bank as comapany has cash balance to maintain compensating balance

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