Question

Lenny borrowed $10,000 on a 5-year interest bearing note with an interest rate of 10%. At the end of 5 years, Lenny must repay the bank $16,105. Based on the amount that must be repaid, interest was calculated with what type of interest rate?

Answer 1

Answer:

compound interest

Explanation:

If the note carried simple interest, then Lenny should repay:

$10,000 + ($10,000 x 5 years x 10%) = $10,000 + $5,000

If the note carried compound interest, then Lenny should repay:

$10,000 x (1 + r)ⁿ = $10,000 x (1 + 10%)⁵ = $10,000 x 1.6105 = $16,105

Compound interest is interest charged over previously earned interest.