A person earns Rs. 2000 per month over and above his salary as additional charge allowance. However, 30% of this additional income will be deducted as additional income-tax at source. If the person would deposit Rs. 1000 per month on a long-term saving fe

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Q: 150 (IAS/1995)
A person earns Rs. 2000 per month over and above his salary as additional charge allowance. However, 30% of this additional income will be deducted as additional income-tax at source. If the person would deposit Rs. 1000 per month on a long-term saving fetching 12% interest his tax liability on the additional allowance would reduce to 10%. What is the effective interest for this person for money invested in the long-term savings scheme ?

question_subject: 

Maths

question_exam: 

IAS

stats: 

0,9,11,7,9,4,0

keywords: 

{'term savings scheme': [0, 1, 0, 0], 'effective interest': [0, 1, 0, 0], 'term saving': [0, 1, 0, 0], 'additional allowance': [0, 1, 0, 0], 'additional charge allowance': [0, 1, 0, 0], 'tax': [0, 0, 0, 1], 'additional income': [0, 1, 0, 0], 'tax liability': [0, 1, 0, 1], 'salary': [3, 2, 3, 4]}

The question is about calculating the effective interest rate that the person would earn from their long-term savings scheme.

Option 1 suggests an effective interest of 12%. This is incorrect, as it only considers the standard interest rate of the savings scheme and does not take into account the tax savings resulting from the investment.

Option 2 suggests 18% as the effective interest. This is the correct answer. This is calculated considering both the standard interest rate of 12% and the additional benefit the person gets due to reduction in his tax liability from 30% to 10% on his additional income. The difference in these percentages, i.e., 20% of the invested amount (Rs. 1000) gives an additional income of Rs. 200, which is effectively an additional interest.

Option 3 and 4, 19% and 20% respectively, are also incorrect as these percentages do not correctly calculate the combination of the standard interest and the tax savings benefit.

To sum up, the effective interest is a combination of the standard interest from the savings scheme and any additional benefits as a result of the investment.