Question

Good Guys will pay you $4,000 a year for 10 years in exchange for $31,300 today. What interest rate will you earn on this annuity? Select one: a. 4.72 percent b. 2.55 percent c. 3.59 percent d. 3.89 percent e. 5.50 percent

Answer 1

The answer is

b. 2.55%

The formula for calculating the interest rate on an ordinary annuity is:

Annual Interest Rate = (Annual Deposit Amount) ÷ (Present Value) x (Annuity Term)

Where A is the annual deposit amount, PV is the present value, N is the number of years invested, and I/Y is the interest rate.

Given that:

$31,300 = (10 x $4,000 x (1 + I/Y)^10)

Solving for the interest rate I/Y, we get:

I/Y = (31300/400000)^(1/10)-1 = 0.02548 or 2.55%