On January 1, 2014, ER signed a $120,000, 10%, three-year, note payable.The proceeds are to be used to purchase a computer and related software for the company.The lending institution advanced proceeds of $115,800 and took a mortgage on the computer.The note is payable in three equal annual instalments starting on December 31, 2014.The effective interest rate to use for this debt is (rounded to the nearest percent; do not interpolate):
A)12%.
B)13%.
C)10%.
D)11%.

Question

Quizplus · Accepted Answer

The effective interest rate is calculated based on the present value of the note's cash flows. The note's face value is $120,000, but the proceeds received were $115,800. The difference indicates a discount, which affects the effective interest rate. By calculating the rate that equates the present value of the note's payments to the proceeds received, the effective interest rate is found to be approximately 12%.

On January 1, 2014, ER Signed a $120,000, 10%, Three-Year