Question

Your company’s sales have doubled since you started advertising online. As a result, you are shopping for a loan to purchase more warehouse space. You want to get the lowest interest rate and you know that when the interest is compounded it can have a significant impact on your loan’s effective rate. Lender A offers you a rate of 12.5% compounded daily. Lender B Offers a rate of 13% compounded annually. Please determine the effective rate for each option. Calculate the difference between the quoted rate and the effective rate. Which option is the better choice for your company and why?

Answer 1

1)Effective Interest rate= (1+r/n)^n-1

r-Interest Rate

n=Number of compounding periods

Therefore effective interest rate for loan from lender A at the rate of 12.5% compounded daily =

{(1+0.125/365)^365-1 }i.e =13.31%

Hence the difference between quoted rate and effective rate= 0.81 % (13.31%-12.5%)

As lender B is offering a rate of 13% compounded annually, it is better to go with company B for financing as its effective annual interest rate is lower by 0.31 % as compared to interest rate of loan from Lender A