EAR vs APR - EAR vs. APR Match the time periods When...

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EAR vs. APR
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Match the time periods When solving cash flow problems, you must make sure that your cash flows and your discount rate have the same time script If you have annual CFs, you need an effective annual rate If you have monthly CFs you need an effective monthly rate Etc.
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Finding the right rate Some problems are easy: you get monthly CFs and an APR with monthly compounding. Divide the APR by 12 to get the effective monthly rate, and match it with your monthly CFs. You are done. Another example: you have annual CFs and you are given an EAR (or simply told that the rate is x%--no mention of a compounding period). Use the effective annual rate with your annual CFs. You are done.
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But it often is not that easy: you are given CFs and a rate from different time frames. Most common mistake: annual CFs and an APR. Even though APR stands for Annual Percentage Rate, you cannot just plug this number in to use with your annual CFs. Why?
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This note was uploaded on 12/10/2011 for the course BTRY 3010 at Cornell University (Engineering School).

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EAR vs APR - EAR vs. APR Match the time periods When...

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