Your company is able to arrange financing at either a rate of 12.75% annually,or at a rate of 12% compounded monthly.Assuming financing is needed for one year,which rate is the best?
A) 12% compounded monthly, because the annual percentage yield is 12.68%.
B) 12.75% annually, because the annual percentage yield for 12% compounded monthly is greater than 12.75%.
C) 12.75% annually, because even though the annual percentage yield is higher, interest if paid only once per year at year end.
D) Both rates are effectively the same, so your company should be indifferent between the two.

Question

Quizplus · Accepted Answer

The best choice is 12% compounded monthly because the annual percentage yield (APY) is higher than 12.75%. To calculate the APY for 12% compounded monthly, we use the formula (1 + (r/n))^n - 1, where r is the annual interest rate and n is the number of compounding periods per year. Plugging in the values, we get (1 + (0.12/12))^12 - 1 = 0.1268 or 12.68%. This means that the effective interest rate with monthly compounding is 12.68%, which is higher than the 12.75% annual rate. Therefore, the company should choose 12% compounded monthly.

Your Company Is Able to Arrange Financing at Either a Rate