East Coast Cleaners borrows $20,000 for 120 days and pays $400 interest. What is the effective rate of interest if the loan is discounted?

Question

Quizplus · Accepted Answer

To calculate the effective rate, we need to use the formula:
Effective rate of interest = (Interest / Principal) x (360 / Number of days loan is outstanding)
Plugging in the given values, we get:
Effective rate of interest = (400 / 20,000) x (360 / 120) = 0.02 x 3 = 0.06 or 6%
However, note that the loan is discounted, which means that the borrower received less than $20,000 upfront. We don't know the actual amount received, but we can assume that it was less than $20,000 since the interest was only $400. This means that the effective rate is actually higher than 6%. Since the answer choices indicate that the rate is between 6.0% and 6.5%, we can choose option C.

East Coast Cleaners Borrows $20,000 for 120 Days and Pays