Question

In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $20,000 and the interest rate is 10%, the borrower "pays" 0.10 × $20,000 = $2,000 immediately, thereby receiving net funds of $18,000 (=$20,000-$2,000) and repaying $20,000 in a year. "What is the implied rate on this loan?"a. 10%b. 9.5%c. 11.1%d. 20%

Answer 1

c. 11.1%

Step-by-step explanation:

The formula to compute the implied rate is shown below:

Future Value = Present Value × (1 + Interest rate)

$20,000 = $18,000 × (1 + Interest rate)

$20,000 = $18,000 × (1 + Interest rate)

So, (1 + Interest rate) = 1.1111

So, the interest rate is

= 1.1111 - 1

= 0.1111 or 11.1%

We simply applied the above formula to determine the implied rate on this loan