Answered: Calulate the effective interest rate.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 14QTD

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Question

Calulate the effective interest rate.

Expert Solution

Step 1

Here,

Value of Note is $29,059

Simple Interest Rate is 8%

Time Duration of Note is 12 months

Step 2 a) Calculation of Effective Interest Rate:

The effective interest rate of a simple interest note will remain 8 % only as the value of the note will remain the same.

In order to calculate the effective Interest rate, we need to calculate the value of simple discount note which is as follows:

Calculation of Interest on Note is as follows:

$\begin{array}{rcl} S i m p l e I n t e r e s t & = & P R T \\ = & $ 29, 059 \times . 08 \times \frac{12}{12} \\ = & $ 2, 324.72 \end{array}$

Calculation of Value of Simple Discount Note is as follows:

$\begin{array}{rcl} V a l u e o f S i m p l e D i s c o u n t N o t e & = & P r i n c i p a l - I n t e r e s t \\ = & $ 29, 059 - $ 2, 324.72 \\ = & $ 26, 734.28 \end{array}$

Calculation of Effective Interest Rate is as follows:

$\begin{array}{rcl} E f f e c t i v e I n t e r e s t R a t e & = & \frac{I n t e r e s t A m o u n t}{V a l u e o f D i s c o u n t N o t e} \\ = & \frac{$ 2, 324.72}{$ 26, 734.28} \\ = & 0.08695652173 \\ = & 8.70 % \end{array}$

Answer: Effective Interest Rate is 8.70%

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