Matthews Manufacturing is negotiating a one-year credit line with its bank, Worldwide Bank. The amount of the credit line is $6.5 million with an interest rate set at 1.5% above the prime rate. A commitment fee of 0.50% (50 basis points) will be charged on the unused portion of the line. No compensating balances are required, and the loan is made on a 365-day basis.
a. If the prime rate is assumed constant at 4.25% during the term of the loan and Matthews’ average loan outstanding during the year is $5.0 million, calculate the firm’s effective borrowing rate (EBR).
b. What effect would an increase in the prime rate to 4.75% for the entire year have on Matthews’ effective borrowing rate (EBR) calculated in part (a)?
c. What effect would a decrease in Matthews’ average loan outstanding during the year to $4.0 million have on the effective borrowing rate (EBR) calculated in part (a)?
d. Using your findings in parts (a), (b), and (c), discuss the effects on Matthewss EBRs of interest rate changes versus changes in the average loan outstanding.