How Do You Calculate Interest Rate?

This can be a burning question among many people including business owners. We put this together to help you break it down into pieces to make the process a bit simpler.

Can I find the interest rate amount on my loan paperwork?

  • You might find it on the note, next to the principal amount.
  • Usually the amount of the pre-computed interest can appear on installment loan documents. However, the lease document does not show the equipment cost or the interest rate.

When a loan is booked, the lessee books the equipment cost as registered as a capital equipment purchase. The equipment is depreciated under the Modified Accelerated Cost Recovery System (MACRS).

So how do I determine the equipment cost, and the interest rate in a Capital lease with a bargain purchase option?

GAPP has provided a procedure to determine these numbers:

  • First discount the lease payment (or rent if you prefer) at the incremental bowering rate (IBR) (average cost of money over like term on secured transactions) to determine the net present value (NPV) of the rent stream.
  • Then they subtract the NPV from the total rent to determine the interest.

If you discount the rent at your IBR, then the interest will be equal to the IBR. On occasion if the lessor’s actual return is higher than the lessees IBR it will become part of the NPV not the interest rate.

Here’s an example:

Consider a $100,000 loan at 10% over 60 months with payments of $2,124.70 in arrears. The equipment cost is clearly $100,000, and the total interest is $27,482.26. Now we will price a lease with a $1 purchase option with a $100,000 at 12% over 60 months with payments of $2,202.42 in Advance. The lessee would discount the rent of $2,202.42 at their IBR at let’s say 9%. The discount would yield a NPV of $106,893.76. This amount would be booked as the equipment cost, and after subtracting this cost from the total rent the interest would be $25,251.44 reflecting a 9% rate.

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