On November 1, 2020, FastCare sold $5,000,000 of three-year bonds for $4,750,325. From the proceeds, the company paid accounting fees of 50,000. Interest of 5% is payable annually. What is the effective rate of interest (round to 2 decimal places)?
A)7.30%
B)5.00%
C)4.69%
D)3.63%

Question

Quizplus · Accepted Answer

The effective interest rate can be calculated by considering the net proceeds from the bond sale (after accounting fees) and the annual interest payments. The net proceeds are $4,750,325 - $50,000 = $4,700,325. The annual interest payment is 5% of the face value, which is $5,000,000 * 5% = $250,000. The effective interest rate is found by dividing the annual interest payment by the net proceeds and then converting it to a percentage, which results in a rate higher than the nominal rate of 5% due to the discount at which the bonds were sold and the accounting fees. Using financial calculators or software to solve for the effective rate gives an answer close to 7.30%.

On November 1, 2020, FastCare Sold $5,000,000 of Three-Year Bonds