Jeremy is in the process of purchasing a car. The list price of the car is $42,000. If Jeremy pays cash for the car, the dealer will reduce the price by 10%. Otherwise, the dealer will provide financing where Jeremy must pay $8,990 at the end of each of the next five years. Compute the effective interest rate to the nearest percent that Jeremy would pay if he chooses to make the five annual payments?
A) 5%.
B) 6%.
C) 7%.
D) 8%.

Question

Quizplus · Accepted Answer

The effective interest rate can be found using the formula for the present value of an annuity. Given that the cash price is $42,000 with a 10% discount, the cash price would be $42,000 - ($42,000 * 0.10) = $37,800. Jeremy would instead pay 5 annual payments of $8,990. Using a financial calculator or an equivalent financial function in a spreadsheet, you can solve for the interest rate that equates the present value of these payments to $37,800. The rate that does this is approximately 6%, making option B correct.

Jeremy Is in the Process of Purchasing a Car