Question

Digital Access Inc. needs \(400,000 in funds for a project.

b. Given your answer to part a and a stated interest rate of 9 percent on the total amount borrowed, what is the effective rate on the \)400,000 actually being used?

Short answer

The effective interest rate is 11.25%.

Step-by-step solution

Information available

Amount required to be borrowed = $500,000

Interest rate = 9%

Calculation of interest payable

The interest payable is $45,000.

$\begin{array}{rcl}\mathrm{Interest}\mathrm{payable}& =& \mathrm{Interest}\mathrm{rate}\times \mathrm{Principal}\\ & =& 9\%\times \$500,000\\ & =& \$45,000\end{array}$

Calculation of effective interest rate

The effective interest rate is 11.25%.

$\begin{array}{rcl}\mathrm{Effective}\mathrm{interest}\mathrm{rate}& =& \frac{\mathrm{Interest}\mathrm{payable}}{\mathrm{Principal}}\\ & =& \frac{\$45,000}{\$400,000}\\ & =& 11.25\%\end{array}$