A five-year, non-interest-bearing, $5,000 note, dated January 1, 2017, has a present value of $3,917. The market rate of interest is 5%. Interest expense for the period ending December 31, 2017, is
A)$392.
B)$196.
C)$250.
D)$217.

Question

Quizplus · Accepted Answer

The present value of the note is $3,917, which means that is the amount that would need to be invested today at the market rate of interest (5%) in order to have $5,000 in five years.

To calculate interest expense for the first year (ending December 31, 2017), we need to determine the interest rate that was used to discount the note. We can solve for this rate using present value formula:

Present value = Future value / (1 + interest rate)n

$3,917 = $5,000 / (1 + interest rate)5

Solving for the interest rate, we get 4%. This is the rate that was used to discount the note.

Interest expense for the first year can now be calculated:

Interest expense = outstanding balance x market interest rate 
Outstanding balance = face value of note - amount of principal paid 
Amount of principal paid = 0 (since this is a non-interest bearing note)

Outstanding balance = $5,000 
Interest expense = $5,000 x 5% = $250

Therefore, the answer is B) $196.

A Five-Year, Non-Interest-Bearing, $5,000 Note, Dated January 1, 2017, Has