On January 1,2014,DWW borrowed $400,000 cash and signed a one-year,12 percent interest-bearing note payable.Assuming a 40 percent average income tax rate for DWW Corporation,the net effective interest rate on this note was:
A) 4.8 percent.
B) 6.0 percent.
C) 7.2 percent.
D) 12.0 percent.

Question

Quizplus · Accepted Answer

To calculate the net effective interest rate, we need to take into account the tax impact on the interest payment. The interest expense on the note payable is $48,000 (12% of $400,000). However, since DWW Corporation can deduct the interest expense from its taxable income, the after-tax interest expense is only $28,800 ($48,000 x 0.6).

To calculate the net effective interest rate, we divide the after-tax interest expense by the amount of the loan:

Net effective interest rate = after-tax interest expense / loan amount
                      = $28,800 / $400,000
                      = 0.072 or 7.2%

Therefore, the answer is C) 7.2 percent.

On January 1,2014,DWW Borrowed $400,000 Cash and Signed a One-Year,12