Valley Rendering, Inc. is considering purchasing a new flotation system for grease recovery. The company can finance a $150,000 system at 5% per year compound interest or 5.5% per year simple interest. If the total amount owed is due in a single payment at the end of 3 years, (a) which interest rate should the company select, and (b) how much is the difference in interest between the two schemes?
What will be an ideal response?
(a) Total due; compound interest = 150,000(1.05)(1.05)(1.05)
= $173,644
Total due; simple interest = P + Pni
= 150,000 + 150,000(3)(0.055)
= 150,000 + 24,750
= $174,750
Select the 5% compound interest rate
(b) Difference = 174,750 – 173,644
= $1106
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