How does a financial manager choose between stated interest and an effective interest

vgray · #1 Dec 12, 2007, 10:42 AM

When a borrower is often confronted as a stated interest and an effective interest rate what is the difference and which one should the financial manager recognize as the true cost of borrowing?

The effective interest rate is always calculated as if compounded annually. The effective rate is calculated in the following way, where r is the effective rate, i the nominal rate, and n the number of compounding periods per year (for example, 12 for monthly compounding):

effective rate is the interest rate on a loan or financial product restated from the nominal interest rate as an interest rate with annual compound interest

I got this part but I don't understand on how a financial manager would choose for the borower?



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