FINANCIAL MATHEMATICS – GRADE 11

P – Principal amount. This is the original amount borrowed or invested.

A – Accumulated amount. This is the total amount of money paid after a period of n
years. It includes the original amount P plus the interest.
i – interest rate per annum.
n – number of years.

SIMPLE INTEREST FORMULA : A  P(1 i.n) annually

COMPOUND INTEREST FORMULA : A  P(1 i) n annually

Example :

R70 000 is taken as a loan to start a small business. The loan is repaid at the end of 5
years in one lump sum payment. Calculate how much money will be required to repay the
loan in each of the following cases.

a) The interest is calculated at 12% p.a. simple interest.

b) The interest is calculated at 12% p.a. compounded annually.

Solution :

P = R70 000 ; A = ? ; n = 5 ; i = 12% = 0,12

a) A  P(1 i.n) b) A  P(1 i) n

= 70 000(1 + 0,12.5) = 70 000(1 + 0,12) 5
= R112 000 = R123 363,92

You will notice that one pays R11 363,92 more interest in (b) than in (a).

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Example :

Toby invests R30 000 in a savings fund for a period of 8 years. The total growth of the
fund amounts to R65 000 after 8 years.

a) Calculate the interest rate per annum compounded annually that would yield the
same return.

b) Calculate the simple interest rate per annum that would provide the same return.

Solution :

A = R65 000 ; P = R30 000 ; n = 8 ; i = ?

a) A  P(1 i) n b) A  P(1 i.n)

65 000 = 30 000(1 + i ) 8 65 000 = 30 000(1 + i .8)
65000 65000
= (1 + i ) 8 = 1 + i .8
30000 30000
65000 65000
8 =1+ i -1 = 8 i
30000 30000
65000
8 -1= i i = 0,145833… (divide by 8)
30000
i = 0,10147…
 rate = 14,58% p.a. (2 d.p.)
 rate = 10,15% p.a. compounded
annually. (2 d.p.)

N.B. Do not round off any answers until the final step.

Interest can be compounded at any regular period of time during the year :
 semi-annually
 quarterly
 monthly
 daily

In general, if a principal P is invested for n years at a nominal rate i (m ) % p.a.

m n
 i ( m) 
compounded m times per year, then A  P1  
 m 

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Example :

R45 000 is deposited into a savings account. Calculate the value of the savings
after 7 years in each of the following cases if the interest rates are :
a) 14% p.a. compounded annually
b) 14% p.a. compounded quarterly
c) 14% p.a. compounded monthly
d) 14% p.a. compounded daily

Solution :
m n
 i ( m) 
a) A  P(1 i) n
b) A  P1  
 m 
P  45000 ; i  0,14 ; n  7 P  45000 ; i ( m)  0,14 ; m  4 ; n  7
4 7
 0,14 
A  45000(1 0,14) 7 A  450001  
 4 
= R112 602,10 = R117 907,74

m n m n
 i (m)   i (m) 
c) A  P1   d) A  P1  
 m   m 
P  45000 ; i ( m)  0,14 ; m  12 ; n  7 P  45000 ; i ( m)  0,14 ; m  365 ; n  7
12 7 365 7
 0,14   0,14 
A  450001   A  450001  
 12   365 
= R119 222,31 = R119 878,00

N.B. The more often the interest is added, the greater the effective interest rate.
e.g. 14% p.a. compounded daily will yield a greater return than 14% p.a.
compounded monthly.

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EFFECTIVE AND NOMINAL INTEREST RATES

 Nominal rate – quoted interest rate [ i (m ) ]

 Effective rate – equivalent annual interest rate [ i ]

m
 i ( m) 
FORMULA : 1  i  1  
 m 

Examples :

1. Convert 11% p.a. compounded quarterly to the effective annual interest rate.
2. Convert an effective annual interest rate of 14,2% p.a. to a nominal annual
interest rate compounded monthly.

Solutions :

1. i ( 4)  11%  0,11; m  4 (quarterly i.e. 4 times per year)

m
 i ( m) 
1  i  1  
 m 
4
 0,11 
1  i  1  
 4 
1i  1,11462...
i  0,11462...
 the effective interest rate is 11,46% p.a. (2 d.p.)

2. i  14,2%  0,142 ; m  12 (monthly i.e. 12 times per year)

m
 i ( m) 
1  i  1  
 m 
12
 i (12) 
1  0,142  1  
 12 
(12)
12 1,142  1 
i
12
12( 1,142 1)  i (12)
12

i (12)  0,13351...
 the nominal interest rate is 13,35% p.a. compounded monthly. (2 d.p.)

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TIME LINES

A time line is a useful way to summarise and represent information in problems

concerning investments and loans , especially when there are a number of withdrawals or
deposits , and changes in interest rate.

Example :

R5 700 is deposited into a savings account, and 2 years later another R1 900 is added to
the savings. A final deposit of R4 100 is made 5 years after the initial deposit. The
interest rate for the first 3 years is 13% p.a. compounded quarterly, and is then decreased
to 11,2% p.a. compounded monthly. Calculate how much money is accumulated in the
savings account at the end of 8 years.

Solution :

Consider the first deposit of R5 700.

At T8 , this amount accumulated will be :
43 125
 0,13   0,112 
5 7001   1   . Notice the change of interest rate.
 4   12 
Consider the second deposit of R1 900.
At T8 , this amount accumulated will be :
41 125
 0,13   0,112 
19001   1   . Notice the change of interest rate.
 4   12 
Consider the final deposit of R4 100.
At T8 , this amount accumulated will be :
123
 0,112 
41001   .
 12 

Hence the total amount at the end of 8 years will be :

43 125 41 125 123
 0,13   0,112   0,13   0,112   0,112 
5 7001   1    19001   1    41001  
 4   12   4   12   12 
= R24 108,19

Note : This is done as one calculation on the calculator.

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DEPRECIATION

Depreciation is the loss in value of an asset through age.

1. Straight-line depreciation – the depreciation is the same every year. It is
a percentage of the original value of the asset. The value of the asset is
reduced to zero over a period of time.

FORMULA : A  P(1  i.n)

2. Reducing balance depreciation – the depreciation is based on the previous

year’s value. Every year the depreciation will be a percentage of the reduced
value of the asset. The loss in value will become less each year. The asset always
has some value at the end of the period.

FORMULA : A  P(1  i) n

Example :
A company buys office furniture at a value of R860 000. Calculate the value of the
furniture at the end of 6 years if depreciation is calculated at 14% p.a. on :
a) a straight-line basis
b) a reducing balance.

Solution :
a) A  P(1  i.n)
= 860 000[1-0,14(6)]
= R137 600

b) A  P(1  i) n
= 860 000 (1  0,14) 6
= R347 927,82

You will notice a large difference between the depreciation on a straight-line basis
compared to the depreciation on a reducing balance.

Note :
 Book Value is the value of an asset after depreciation has been taken into account
for a given number of years.
 Scrap Value is the book value of an asset at the end of its useful life.
 A Sinking Fund is the fund set up to replace an asset at the end of its useful life.

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SINKING FUND

Example :
A company buys a truck for R450 000. The truck depreciates on a reducing balance basis
at a rate of 20% p.a.

a) Calculate, to the nearest rand, the book value of the truck at the end of 5 years.

b) At the end of each year, the company deposits R52 000 into a sinking fund to
replace the truck. The sinking fund starts one year after the truck was bought and
the last deposit is made at the end of the fourth year. How much money is in the
fund at the end of 5 years ? The interest rate on the sinking fund is 13% p.a.
compounded annually.

c) In 5 year’s time, a new truck is expected to cost R530 000. How much additional
money is required to purchase a new truck at the end of 5 years if the old truck is
sold at its book value and that money, together with the money from the sinking
fund, is used as payment towards the new truck ?

Solution :
a) A  P(1  i) n
= 450 000 (1  0,20) 5
= R147 456

b)

An efficient way of solving the problem is to do one calculation, taking the value
of each deposit together with the interest earned to T5 , and then adding them
together.

52 000 (1  0,13) + 52 000 (1  0,13) 2 + 52 000 (1  0,13) 3 + 52 000 (1  0,13) 4

= R284 974,07

c) The amount of money available = R284 974,07 + R147 456

= R432 430,07

Therefore, the additional money required = R530 000 – R432 430,07

= R97 569,93