Pelforth & Co. was just granted a 2-year, $1 million revolving line of credit with Ocean Bank under the following terms and conditions:
• Commitment fee = 0.75% of unused portion of the line, payable quarterly in
arrears.
• Interest rate = 2.25% over 3-month LIBOR (interest paid quarterly in arrears).
• Assume a 360-day year (è 12 months of 30 days each).
• The 3-month LIBOR is currently at 3% and is not expected to change this
year (Year 1). Next year (Year 2), it is expected rise to 3.5% and remain stable
during that year.
Pelforth plans to borrow the full $1,000,000 on Day 1 and reimburse half of the
amount at the end of the 1st year (at the close of Day 360). It plans to continue
borrowing the remaining $500,000 under the line until the end of the 2nd year.
What will be Pelforth's average effective borrowing rate (expressed as an
Effective Annual Rate of interest - EAR) during the 2-year period under the line of
credit according to the above borrowing scenario?