Question

You can buy an item for $125 on a charge with the promise to pay $125 in 60 days. Suppose you can buy an identical item for $115 cash. If you buy the item for $125, you are in effect paying $10 for the use of $115 for two months. What is the effective annual rate of interest? Enter your answer as a percentage rounded to two decimal places.

Answer 1

Answer:

Effective annual interest rate=0.52%

Explanation:

Step 1: Express the formula for calculating interest

The formula for calculating interest can be expressed as;

I=PRT

where;

P=principal amount borrowed

R=annual interest rate as a percentage

T=number of years

Step 2: Determine the value of the variables P, R and T

In our case;

I=$10

P=(125-10)=$115

R=unknown=r

T=2 months=2/12=1/6 years

replacing in the expression;

10=115×r×(2/12)

10=(230/12)r

r=10×12/230=0.5217

0.5217 rounded off to the nearest 2 decimal places is:

r=0.52%

Effective annual interest rate=0.52%