Commercial Bank Credit

1) Firm A borrows $1 million from a commercial bank. The bank charges an annual rate of 10%
and requires a 3% origination fee.

How much does the firm have to borrow to have $1 million?

Confirm your answers and determine the effective rate of interest.

Computation Using the Annual Rate

Amount of the loan = Funds Needed

1.0 – The stated rate of interest

= $1,000,000.00
1.0 - 0.1

= 1,000,000.00
0.90

Amount of the loan = $1,111,111.11

Amount Borrowed $1,111,111.11

Interest Paid in Advance ( $1,111,111.11 x .10 ) 111,111.11
Amount available $1,000,000.00

Effective Interest Rate:

i= Interest Paid 12
Proceeds of the loan x 12

= 111,111.11 x 12
1,000,000.00 12

= 11.11%

Computation Using the Origination Fee

Amount of the loan = Funds Needed
1.0 – The Origination Fee

= $1,000,000.00
1.0 - 0.03

= 1,000,000.00
0.97

Amount of the loan = $1,030,927.84

Amount Borrowed $1,030,927.84

Interest Paid in Advance ( $1,030,927.84 x .03 ) 30,927.84
Amount available $1,000,000.00

Effective Interest Rate:

i= Interest Paid 12
Proceeds of the loan x 12

= 30, 927.84 x 12
1,000,000.00 12

= 3.09%