Answer (C) is correct . The annual cost of Red’s financing arrangement can be calculated as follows: Annual cost = Interest expense on average balance + Commitment?fee?on?unused?portion = (Average balance × Stated rate) + [(Credit limit – Average balance) × Commitment?fee?%] = ($100,000 × 6%) + [($300,000 – $100,000) × 0.5%] = $6,000 + $1,000 = $7,000
Answer (A) is incorrect because The amount of $6,000 results from improperly excluding the 1/2% commitment fee.
Answer (B) is incorrect because The amount of $6,500 results from improperly applying the 1/2% commitment fee to the used portion of the line of credit, rather than the unused portion.
Answer (D) is incorrect because The amount of $7,500 results from improperly applying the 1/2% commitment fee to the total line of credit rather than only the unused portion.
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