Each year the $315.47 receipt represents 10% interest on the unrecovered balance in column 2
plus the recovered amount in column 5.
Because rate of return is the interest rate on the unrecovered balance, the computations in
Table 7–1 for part (a) present a correct interpretation of a 10% rate of return. Clearly, an interest
rate applied only to the principal represents a higher rate than is stated. In practice, a socalled
add-on interest rate is frequently based on principal only, as in part ( b ). This is sometimes
referred to as the installment financing problem.