On October 31, 2019, Simeon Builders borrowed $1,200,000 cash from Star Finance Co. by issuing a $1,250,000 6-month, non-interest-bearing note. Simeon Builders' effective annual interest rate on this loan is:

a. 8.3%
b. 4%
c. 8%
d. 4.2%

The correct option is A,8.3% effective interest yearly.

Explanation:

The bond is issued at a  discount to its par value. Invariably, par value  of $1250000 is payable in six months,since there is no coupon interest payable on the bond,effective interest paid  is the difference between amount payable on redemption and the discounted value at which it was issued.

Effective interest %=$1250000-$1200000/$1200000

                            =4.17% (for six months)

Effective annual interest =4.17%*2

                                         =8.3%

It is imperative to know that effective interest is calculated on the proceeds from bond issue while coupon interest is computed as a percentage of face value.

A. 8.3%

Explanation:

The question is to determine Simeon Builders Effective rate. When we say effective rate, in this question, we simply referring to the interest rate paid annually on the borrowed amount.

First,

what is the borrowed amount= $1,200,000

What is the amount to be repaid = $1,250,000

We then determine the total interest paid = $1,200,000- $1,000,000

= $50,000

Finally, we calculate the interest rate as follows= Interest rate / Borrowed amount

= $50,000/ $1,200,000 x 100= 4.17%

Also, since the 4.17% computed is for a 6 month period

The annual effective interest rate = (4.17/ 6) x 12 = 8.3$

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