Certified Management Accountant Practice Exam 2025 - Free CMA Practice Questions and Study Guide

The effective rate on a discounted loan is calculated using the formula that represents the relationship between the stated rate and the amount of loan proceeds actually received. The chosen formula, which divides the stated rate by one minus the stated rate, reflects how much of the loan is effectively utilized after accounting for the discount at the onset.

In a discounted loan, the lender subtracts the interest cost from the loan proceeds given to the borrower. As a result, the borrower is repaying more than the actual funds received, making the effective interest rate higher than the stated rate. By using the formula, you arrive at the effective rate that takes into account the reduced amount of loan proceeds available for use.

This approach correctly captures how the loan discount impacts the overall cost of borrowing. The alternative formulas do not directly represent this relationship, and thus they do not accurately reflect the computation of the effective interest rate in the context of a discounted loan scenario.