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Sir, I read your answer recently where u said that the effective interest rate formula is used to calculate the effective annual interest & it is relevant when looking at the management of receivables & payables and calculating the cost of the benefit of giving or receiving discounts.
Is it true that the discount rate that we calculate in the management of receivable chapter is based on the effective annual interest rate which is the cost of giving discount to the customers?
Is that correct that you have calculated effective % cost p.a. of the discount in example 1 (chap 5) as you explained in your lectures by this formula below:
Effective Interest rate = (1+ i/n)^n – 1
Effective Interest rate = (1+ 0.04/12)^12*6 – 1
But it doesn’t give me the right answer 27.75%
Can you please correct me with my calculation?Firstly, you would only divide by 12 if you were given a yearly simple interest rate and wanted to get the monthly interest rate, Here the two monthly interest rate is 4/96 = 4.1667% and so you don’t need to divide it by anything.
Secondly, to convert 4% every 2 months into a yearly rate we take it to the power of 12/2 i.e. 6 (because there are six periods of 2 months in a year).
(1.041667)^6 – 1 = 0.2775 or 27.75%
The post you were referring to was for a Paper MA question. For Paper FM it is only relevant for the management of receivables and payables. Don’t just learn formulas for Paper FM – the examiner tests your understanding, not that you have simply learned formulas.
Have you watched the free lectures that go with the notes, because I work through this example in the lectures and explain why the figures are as they are?
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