Sergeant Jess Frugal has the problem of running out of money near the end of each month (he gets paid once a month). Near his army base there is a payday lender company, called Predatory Lenders, Inc., that will give Jess a cash advance of $350 if he will repay the loan a month later with a post-dated check for $375. Almost as soon as Frugal’s check for $375 clears the bank, he unfortunately must again borrow $350 to make ends meet. Jess’s wife has gotten a bit concerned that her husband might be paying an exorbitant interest rate to this payday lender. Assuming Jess has repeated this borrowing and repayment scheme for 12 months in a row, what effective annual interest rate is he really paying? Is Jess’s wife correct in her worry? Hint: Draw a cash-flow diagram from the viewpoint of the lender.
Sergeant Jess Frugal has the problem of running out of money near the end of each month (he gets paid once a month). Near his army base there is a payday lender company, called Predatory Lenders, Inc., that will give Jess a cash advance of $350 if he will repay the loan a month later with a post-dated check for $375. Almost as soon as Frugal’s check for $375 clears the bank, he unfortunately must again borrow $350 to make ends meet. Jess’s wife has gotten a bit concerned that her husband might be paying an exorbitant interest rate to this payday lender. Assuming Jess has repeated this borrowing and repayment scheme for 12 months in a row, what effective annual interest rate is he really paying? Is Jess’s wife correct in her worry? Hint: Draw a cash-flow diagram from the viewpoint of the lender.
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