Future Business Leaders of America (FBLA) Business Calculations Practice Test

What is the formula used to calculate monthly payments on a loan?

1. Loan amount times interest rate

2. Loan amount divided by months

3. Loan amount times monthly interest divided by one minus (1 plus rate to the power of negative n)

4. Loan amount minus any fees

The correct answer is: Loan amount times monthly interest divided by one minus (1 plus rate to the power of negative n)

The formula to calculate monthly payments on a loan incorporates several factors, specifically the principal loan amount, the monthly interest rate, and the number of payments. In option C, the formula presented is effectively the method to determine the fixed monthly payment for an amortizing loan - where the payments are the same every month over the term of the loan. The expression "loan amount times monthly interest divided by one minus (1 plus rate to the power of negative n)" accounts for the compounding nature of interest. The monthly payment formula is based on the concept of the present value of an annuity, where you need to account for the fact that each payment includes both principal repayment and interest. The "monthly interest" serves as the rate applied each month rather than the annual rate. The term "(1 + rate to the power of negative n)" helps to discount the series of future payments back to their present value, allowing borrowers to understand how much they need to pay over the term of the loan to fully pay it off. This formulation captures not just the principal and interest, but the specifics of how interest compounds over time, which is critical in determining accurate monthly payments. In contrast, the other options either oversimplify the calculation by excluding necessary components (