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Doyouknow,Ifsomeonewantstobuyabyke,oracostlymobileorifyourfatherwantstopurchaseanewflat,
theygeneralltakeloanfromabankorfromafinancier.Theyneedtopaymonthlyinstallments.Today,acrossthe
world,alltheEMI's(EquatedmonthlyInstallments)arebeingcalculatedoncompoundinterest.
Soafterreadingthisarticle,youmustbeinapositiontocalculatetheEMIyouaregoingtopayforyournewbyke
purchase!!
Beforethat,letustrytounderstandthemeaningofcompoundinganddiscounting.Weknowthatdailypricesofthe
goodsincreaseatarate.Assume,AproductwhichcostsRs.100costsRs.110nextyearandRs.121thatnext
year.Suppose,YoulendRs.100toyourfriendandhepromisedtogiveyouRs.100after1year.Doyouaccept
it?Outoffriendshipweaccept.Butthinklikeafinancier.IfyoureceiveRs.100after1yearthevalueofthis100
rupeemaynotbuythesameamountofgoodsitwouldhavepurchasedtodayasthepriceswentuptoRs.100.So
weneedtochargesomeinterest.Sohowmuchistheinterest?
Weusetheformulaofcompoundinterest.
P (1 +

) = A 100 (1 +

100

) = 110

100

Itisclearthatinterestrateis10%
Thatmeans,iftheinterestrateis10%,Rs.100todayisequaltoRs.110earnedafter1yearandRs.121after2
years.

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HowEMI'swork:
Ifabuyersellsaproducttoyouatfullpaymentgetsomeinterestonyouramountfornperiods.Thistotalamount
shouldequaltosumofallEMI'sandtheinterestsaccruedoneachEMIfortheremainingperiod.Thenonlythe
sellerdidnotgetanyloss.

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Assumewehavetakenaloanatperiod0andhavetopayinstallmentsattheendof1,2,3,4thperiodsofxeach.
NowloanamountplustheinterestonthetotalloanamountPatR%ratefor4periodsisequaltoalltheEMI'sand
interestsearnedfortheremainingperiod.ThatistheEMIintheperiod2earns2periodsinterestandEMIinthe
3rdperiodearnsonly1periodinterest.

P (1 +

= x(1 +

100

+ x(1 +

100

100

+ x(1 +

+x

100

WeshouldalsosolvethisproblembyPresentValue(PVmethod).Youlearnthisconceptinanyfinancetext
book!!
WealreadylearntthatRs.110earnedafter1yearisequaltoRs.100earnedtodayiftheinterestrateis10%
SoRs.110discountedat10%givesyouRs.100.Don'tworryhowtodothis.Thisisquitesimple.Youhaveto
calculatePfromthecompoundinterestformula.
A

P =
(1 +

100

HereA=Rs.110,R=10%,n=1.

Fromtheabovediagram,ifwehavetakenloanfor4periods,thelastinstallmentshoulddiscountfor4periodsand
soon.
SoP

=
(1 +

(1 +

100

+
(1 +

100

100

(1 +

100

1.ApersonborrowedasumofRs6000at10%p.a.,interestcompoundedannually.Ifthemoneyistoberepaidin
threeequalannualinstallment,eachpayableattheendoftheyear,thenwhatisthevalueofeachinstallment?
a.Rs.2,000b.Rs2,413c.Rs2,314d.Rs2,662
Sol:Sumborrowed=Rs6000
Interest=10%atcompoundedannuallyandtime=3years
Letxbetheamountpaidattheendofeachofthe3years.
6000(1 +

10

100
6000(1.1)

10

= x(1 +

+ x (1 +

100

10

)+x

100

= 1.21x + 1.1x + x

6000(1.331)
x =

= 2412.68
3.31

SoInstallmentamountisRs.2413
Tip:Usetheembeddedcalculatortocheckyouraccuracy.multiplyinterestratewith12anddivideyearswith12.
SoR=120,Period=0.25,LoanAmount=6000
2.Threeequalinstallment,eachofRs200,werepaidattheendofyearonasumborrowedat20%compound
interestcompoundedannually.Findthesum.

a.Rs600b.Rs400c.Rs421.30d.Rs432.10
Sol:InstallmentseachofRs200for3years.
20

x(1 +

100
x(1.2)

20

= 200(1 +

+ 200 (1 +

100

20

20

) + 200 (1 +

100

100

= 200(1.44) + 200(1.2) + 200

x(1.718) = 200(3.64)
200(3.64)
x =

= 421.3
1.718

AlternateMethod:
weusediscountingmethod.Wediscounttheinstallmentsforthepresentvalue.
200

P =

20

(1 +

200

(1 +

100
P =

200
1.2

200

20

200

100
+

1.44

20

(1 +

100

200
1.718

P=421.3
3.Amanborrowsacertainsumofmoneyandpaysitbackin2yearsintwoequalinstallments.IfC.I.isreckoned
at5%perannumandhepaysbackannuallyRs.441,whatsumdidheborrow?
a.Rs.820b.Rs.800c.Rs.882d.Rs.850
441

Sol:MoneyborrowedwhichbecomesRs.441afteroneyear=

(1 +

100

=441x(20/21)=Rs.420.
MoneyborrowedwhichbecomeRs.441aftertwoyears=

441

(1 +

=441x(20/21)x(20/21)=Rs.400.
)

100

Totalmoneyborrowed=Rs.820.
GeneralDiscussionOnEMI's:
SupposeyouhavetakenaloanofRs.100000tobuyahouseat12%ratetobepaidEMI'sfor60months.
TheyusethisformulaEMI=

P r (1 + r)
(1 + r)

Herer=Rate/1200

n=periods(5years=60periods)

SampleLoanSchedule:

CarWaleEMISchedule
FollowingScheduleIsFor:100000torepayin60months.
AllcalculationsarebasedonEMIinArrears(i.e.RearEndedEMI's).

EMINumber EMIAmount InterestAmount PrincipalReduction BalanceDue


1.

Rs.2224

Rs.1000

Rs.1224

Rs.98776

2.

Rs.2224

Rs.988

Rs.1237

Rs.97539

3.

Rs.2224

Rs.975

Rs.1249

Rs.96290

4.

Rs.2224

Rs.963

Rs.1262

Rs.95028

5.

Rs.2224

Rs.950

Rs.1274

Rs.93754

Monthlyinterestis1%permonth.Nowafter1month,interestaccruedis1000.OfthetotalEMIofRs.2224,
Rs.1000usedforinterestandtheremainingRs.1224forprincipalreduction.NowBalanceofRs.98776becomes
theprincipalfornextmonth.Sointerestis987.7orRs.988.

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