To get the effective interest rate (EIR) of the loan, determine first whether we will use a simple interest method or a discounted method. In this case, we will use a discounted method because the loan is a discounted one. In a discounted method, interest is deducted from the loan principal. So the formula will look like this:
EIR = Interest ÷ (Principal - Interest)
Before proceeding any further, solve first for interest. (assuming a 360-day year) Interest = Principal × rate × interest = $2950 × (100/360) × (0.085) = $69.65
Thus, EIR can be computed as follows: EIR = ($69.65 ÷ ($2950 - $69.65)) × 360 ≈ 8.7%
Notice that the EIR was multiplied by 360 to return it to an annual rate.
