does this seem right? You have a choice of borrowing money from a finance compan

Question

does this seem right?

You have a choice of borrowing money from a finance company at 21 percent compounded annually or borrowing money from a bank at 23 percent compounded daily. Which alternative is the most attractive? If you can borrow funds from a finance company at 21 percent compounded annually, the EAR for the loan is (Round to two decimal places.) If you can borrow funds from a bank at 23 percent compounded daily, the EAR for the loan is (Round to two decimal places.) Based on the findings above, which alternative is more attractive? (Select the best choice below.) A. The loan from the finance company at 21% compounded annually B. The loan from the bank at 23% compounded daily

Explanation / Answer

The EAR can be calculated with the use of following formula:

EAR = (1+Annual Rate/Compounding Period)^Period - 1

_________

Part A - 21% with Annual Compounding

Here, Annual Rate = 21%, Compounding Period = 1 and Period = 1

Using these values in the above formula for EAR, we get,

EAR = (1+21%/1)^1 - 1 = 21%

_________

Part B - 23% with Daily Compounding

Here, Annual Rate = 23%, Compounding Period = 365 and Period = 365

Using these values in the above formula for EAR, we get,

EAR = (1+23%/365)^365 - 1 = 25.85%

_________

Based on above calculations,

The loan from the finance company (which is Option A) is more attractive as it is available at a lower EAR when compared with Option B.

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