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sir, why are we calculating effective interest rate in below questions?
A building society adds interest monthly to investors’ accounts even though interest rates are expressed
in annual terms. The current rate of interest is 6% per annum.
An investor deposits $1,000 on 1 January. How much interest will have been earned by 30 June?
A $30.00
B $30.38
C $60.00
D $300
If a single sum of $12,000 is invested at 8% per annum with interest compounded quarterly, what is
the amount to which the principal will have grown by the end of year three? (approximately)
A $15,117
B $9,528
C $15,219
D $30,924why should we have to calculate effective interest before using formula of compound interest?
2. How do we know whether we have to use simple interest formula or compound interest formula?
A machine has an investment cost of $60,000 at time 0. The present values (at time 0) of the expected
net cash inflows from the machine over its useful life are:
Discount rate Present value of cash inflows
10% $64,600
15% $58,200
20% $52,100
What is the internal rate of return (IRR) of the machine investment?
A Below 10%
B Between 10% and 15%
C Between 15 and 20 %sir, when we are given 3 discount rates, which two should be used for IRR
First question:
Interest is always compounded. However, when interest is payable monthly or quarterly you need to know the interest per month or per quarter before you can compound it.
Have you watched the free lecture on interest?
Second question:
The question does not ask you to calculate the IRR!! To do so would simply be wasting time.
(If it ask for the IRR, then you could use any two of the interest rates given – the answers will be slightly different because it is always only an approximation, in which case the question would ask for it to the nearest per cent.)The question is simply testing that you understand what the IRR is. Since at 20%, the NPV is positive, it should be immediately obvious that the IRR must be more than 20%.
(I assume that there was a fourth option – D – more than 20%. If not then either you have mistyped the question or it is mistyped in your book.)
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