Essay Question: Worthington, Inc. is planning to issue $7,500,000 in 120-day maturity notes carrying a rate of 11 percent per year. Worthington’s commercial paper will be placed at a cost of $35,000. What is the effective cost of credit to Worthington?
Answer to my essay was:
Assuming Simple Interest (An year has 360 days)
= $7,500,000* 11%* (120/360) =$275,000
= $275,000 + $35,000
= $310,000 (33% and 24% was incorrect interest rate for 120 days)
So the effective cost of credit to Worthington based off the financial principals is 11% annual interest rate paid back in120 days has an effective interest rate of 24%.Therefore, this is the effective cost of credit since it entails all the additional costs involved insecuring the credit.
My professor is asking what is the interest rate for the 120 days? Here are some of her notes to me.
1. If you pay 10% interest and you only have use of the money for 3 months, the effective interest rate is 40%. Interest is stated as an annual number unless otherwise stated. Your answer is incorrect. I am giving you a big clue with my first statement here.
2. Your calculations are partially correct, but partially incorrect. This is an exam and I can’t provide formulas/answers to exams. If, after 6 months, I earned $10,000 interest on an investment of $100,000, what is my return? By financial principles, it is 20%–not 10%.
3. This question combines two concepts-your text has a discussion of a similar problem.
Can some one help me with this answer?