# Calculating EAR with Add-On Interest This problem illustrates a deceptive way of quoting interest rates called add-on

## Question:

Calculating EAR with Add-On Interest This problem illustrates a deceptive way of quoting interest rates called add-on interest. Imagine that you see an advertisement for Crazy Judy’s Stereo City that reads something like this: “$1,000 Instant Credit! 13% Simple Interest! Three Years to Pay low. Low Monthly Payments” you’re not exactly sure what all this means and somebody has spilled ink over the APR on the loan contract, so you ask the manager for clarification.

Judy explains that if you borrow S1,000 for three years at 13 percent interest, in three years you will owe: $1,000 x 1.13 = $1.000 × 1.42290 = $1.442,90

Now, Judy recognizes that coming up with $1,442.90 all at once might be a strain, so she lets you make “low, low monthly payments” of $1,442.90/36 = $40.08 per month, even though this is extra bookkeeping work for her.

Is this a 13 percent loan? Why or why not? What is the APR on this loan? What is the EAR? Why do you think this is called add-on interest?

## Step by Step Answer:

**Related Book For**

## Fundamentals of Corporate Finance

**ISBN:** 978-0077861629

8th Edition

**Authors:** Stephen A. Ross, Randolph W. Westerfield, Bradford D.Jordan