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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

NOMINAL INTEREST RATE AND EXTENDING CREDIT As a jewelry store manager, you want to offer credit, with interest on outstanding balances paid monthly. To carry receivables, you must borrow funds from your bank at a nominal 6%, monthly compounding. To offset your overhead, you want to charge your customers an EAR (or EFF%) that is 2% more than the bank is charging you. What APR rate should you charge your customers?

Summary Introduction

To calculate: Nominal rate, which has to be charged from customers.

Nominal rate of interest: It is that interest rate, which has been quoted without adding the inflation into the account. It also did not include compounding of interest.

Explanation

Solution:

Formula to calculate effective annual rate is,

EAR=(1+INOMM)M1

Where,

  • EAR is effective annual rate.
  • INOM is nominal interest rate.
  • M is compounding period.

Substitute 6% for INOM and 12 for M.

EAR=(1+0.0612)121=0.06167=6.16%

Effective annual rate is 6.16% but the investor wants effective annual rate plus 2% so it will be 8

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