Hatter Enterprises has current assets of $15 million and a current ratio of 3. The bank has offered Hatter a $13 million revolving credit agreement at an interest rate of 10%. Hatter will have to pay a commitment fee of 1% on the unused balance. Assuming that current assets and the current ratio remain constant, calculate the total annual financing charge associated with this agreement if Hatter borrows enough to support all of its net working capital.

A) $1,030,000
B) $1,240,000
C) $1,310,000
D) $1,390,000

Question

Lucas Hilliard · Accepted Answer

Final Answer : A, Explanation :  The total annual financing charge is calculated by adding the interest expense on the borrowed amount and the commitment fee on the unused balance. First, calculate the current liabilities using the current ratio formula: Current Ratio = Current Assets / Current Liabilities. With a current ratio of 3 and current assets of $15 million, the current liabilities are $5 million ($15 million / 3). Net working capital is current assets minus current liabilities, which is $10 million ($15 million - $5 million). If Hatter borrows enough to support all of its net working capital, it borrows $10 million. The interest expense on this amount at 10% is $1 million ($10 million * 10%). The unused balance of the credit agreement is $3 million ($13 million - $10 million). The commitment fee on the unused balance at 1% is $30,000 ($3 million * 1%). Therefore, the total annual financing charge is $1,030,000 ($1 million + $30,000).

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