What is a Implicit Interest Rate?
An implicit interest rate is an interest rate which is not disclosed in a loan agreement but is implied and can be calculated from the repayment terms of the agreement.
How to Calculate Implicit Interest Rate
Suppose a business has a lease agreement with a lender to borrow £20,000 and has to pay back £22,000 at the end of one year. The interest rate implicit in the lease has not been disclosed in the agreement, but we can calculate the implicit interest rate as being (22,000 – 20,000) / 20,000 = 10%.
While this is a simple example over a one year term, the implicit rate will change depending on whether for example repayments are made monthly or annually, at the start or end of the period, or are regular or irregular. Generally, the implicit interest rate can be shown to be the internal rate of return (IRR) of all the cash flows associated with a loan agreement.
For further information see the Wikipedia implicit interest rate definition.
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