The effective rate of a $25,000 non-interest-bearing simple discount 10%, 90-day note is:
A) 10.62%
B) 10.0%
C) 10.8%
D) 10.26%
E) None of these

Question

Quizplus · Accepted Answer

The effective rate is the actual percentage increase in value that the borrower must pay in exchange for receiving funds today instead of at the maturity date.

First, we need to calculate the discount on the note:

Discount = Principal x Rate x Time 
Discount = $25,000 x 0.10 x 90/360 
Discount = $625

Next, we need to determine the proceeds (amount received) of the note:

Proceeds = Principal - Discount 
Proceeds = $25,000 - $625 
Proceeds = $24,375

The effective rate can now be calculated using the following formula:

Effective Rate = (Discount / Proceeds) x (360 / Time) 
Effective Rate = ($625 / $24,375) x (360 / 90) 
Effective Rate = 0.0256 x 4 
Effective Rate = 0.1024 or 10.24%

Therefore, the best choice is D.

The Effective Rate of a $25,000 Non-Interest-Bearing Simple Discount 10