Sullivan, Inc. would like to finance in euros. European interest rates are curre

Question

Sullivan, Inc. would like to finance in euros. European interest rates are currently 7 percent, and the euro is expected to depreciate by 3 percent over the next year. What is Sullivan's effective financing rate next year?
Sullivan, Inc. would like to finance in euros. European interest rates are currently 7 percent, and the euro is expected to depreciate by 3 percent over the next year. What is Sullivan's effective financing rate next year?
Sullivan, Inc. would like to finance in euros. European interest rates are currently 7 percent, and the euro is expected to depreciate by 3 percent over the next year. What is Sullivan's effective financing rate next year?

Explanation / Answer

Formula for effective interest rate is:

r = (1+i/n) n – 1        

r = Effective interest rate

i = Stated interest rate = 7 % or 0.07

n = No. of compounding periods in a year

Depreciation rate of Euro = 3 %

r = (1 + 0.07) x (1 – 0.03) - 1

  = (1.07 x 0.97) – 1

= 1.0379 – 1 = 0.0379 or 3.79 %

Sullivan’s Effective financing rate of next year is 3.79 %

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