Final answer:
The effective interest rate for the zero-interest-bearing note payable, discounted at a rate of 7%, represents the actual cost of borrowing when considering the discount and the time frame. To find it, you discount future payments to their present value and determine the interest resulting from the discount. An example involving a bond issued at $3,000 with an 8% interest rate is given to illustrate the calculation process.
Step-by-step explanation:
The subject question asks us to determine the effective interest rate on a zero-interest-bearing note payable. The note is for $400,000 and is discounted at 7% for 12 months. The effective interest rate is the actual cost of borrowing when the discount and time are considered. To find the effective interest rate, the formula we use is:
at $3,000 with an 8% interest rate. This bond will pay $240 in interest each year ($3,000 x 8%), and at the end of the second year, it will also pay back the $3,000 principal. To calculate the present value of this bond using an 8% discount rate, we would discount each of these future payments back to their present value:
Similarly, for the note payable question, we calculate the effective interest rate using the interest the bank earns, which is the discount on the note, and calculate the actual effective rate provided the discount rate is constant. However, instead of providing the calculation for the given scenario, an example was illustrated to help understand the concept of calculating the effective interest rate.