Question

Andrew just borrowed $60000 to buy a new carrot harvester. The terms of the loan require him to make equal monthly payments for 10 years. His first payment is due in one month. If Andrew must pay $1000 per month, then what is the EAR of his loan?

Answer #1

Information provided:

Present value= $60,000

Time= 10 years*12= 120 months

Monthly payment= $1,000

The question is solved by first calculating the yield to maturity.

Enter the below in a financial calculator to compute the yield to maturity:

PV= -60,000

PMT= 1,000

N= 120

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 1.3220.

Hence, the yield to maturity is 1.3220*12= 15.8640% 15.86%.

Effective annual rate is calculated using the below formula:

EAR= (1+r/n)^n-1

Where r is the interest rate and n is the number of compounding periods in one year.

EAR= (1+0.1586/12)^12-1

= 1.1707 - 1

= 0.1707*100

= 17.07%.

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