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06/07/2018 Conversion, Algebra and Advanced Math 1

OUTLINE:
This part of the lecture series will include topics and problem sets focusing on
the following:
INTEREST
CASH FLOW DIAGRAMS
SIMPLE INTEREST
ORDINARY AND EXACT SIMPLE INTEREST
COMPOUND INTEREST
CONTINUOUS COMPOUNDING
NOMINAL AND EFFECTIVE RATES OF INTEREST
EQUIVALENT NOMINAL RATES

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INTEREST
Interest
-is the amount of money earned by a given capital.
Borrower’s Viewpoint
-is the amount of money paid for the use of borrowed capital.
Lender’s Viewpoint
-is the income generated by the capital that was lent.

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CASH FLOW DIAGRAMS
Conventions used in Cash Flow Diagrams:
• The horizontal (time) axis is marked off in equal increments, one per
period, up to the duration or horizon of the project.
• All disbursements and receipts (cash flow) are assumed to take place at
the end of the year in which they occur. This is known as the year-end
convention. The exception of the year-end convention is the initial cost
(purchase cost) which occur at time t=0.
• Two or more transfers in the same period placed end-to-end may be
combined into one.
• Expenses incurred before t=0 are called sunk cost and are not relevant to
the problem.
• Receipts and disbursements are represented by arrows on opposite sides
of the horizontal time axis.

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SIMPLE INTEREST
Simple Interest
In Simple Interest, the interest earned by the principal is computed at
the end of the investment period, and thus, it varies directly with time.

Ordinary and Exact Simple Interest


Ordinary Simple Interest - the interest is computed on the basis of one
banker’s year.
1 bankers’ year = 12 months
1 month = 30 days ; 1 year = 360 days
Exact Simple Interest - the interest is based on the exact number of
days of the year, where there are 365 days for an ordinary year and
366 days for leap year.
Note: Leap year occurs every four years for years that are exactly divisible by
four, except century marks (1800, 1900, etc.) but not including those that
are exactly divisible by 400 (2000, 2400, etc.)

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SIMPLE INTEREST
Elements of Simple Interest
F=P+I
P = Principal Worth
I = Interest Earned
F = Future Worth
I = Prt
r = simple interest rate per year
t = time in years or fraction of a year
F = P + I = P + Prt
F = P(1+rt)
Note for time (t):
4 years; t = 4
3 months; t = (3/12) = ¼
90 days for Ordinary simple Interest; t = 90/360
06/07/2018 for Interest,
Exact simple Interest;
Simple Interest, t =Interest
Compound 90/365 or 90/366 (for leap year)
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SIMPLE INTEREST (PROBLEM SOLVING)
Problem 1. Find the interest on P6,800.00 for 3 years at 11% simple interest.
P = P6,800.00
r = 11%
t = 3 years
I = Prt
I = P6,800.00 (11%)(3)
I = P2,244.00

Problem 2. A man borrowed P10,000.00 from his friend and agrees to pay at
the end of 90 days under 8% simple interest rate. What is the required
amount?
P = P10,000.00
r = 8%
t = 90 days / 360 days = ¼
F = P (1 + rt) = P10,000
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(1 + 0.08(0.25)) = P10,200.00
Interest, Simple Interest, Compound Interest 7
SIMPLE INTEREST (PROBLEM SOLVING)
Problem 3. Annie buys television set from a merchant who offers P25,000.00 at
the end of 60 days. Annie wishes to pay immediately and the merchant offers
to compute the required amount on the assumption that money is worth 14%
simple interest. What is the required amount?
F = P25,000.00
r = 14%
t = 60 days / 360 days = 1/6
P25,000.00 = P (1 + rt)
P25,000.00 = P (1 + 0.14(1/6))
P = P24,429.97

Problem 4. What is the principal amount if the amount of interest at the end of
2 ½ year of P4,500.00 for a simple interest of 6% per annum?
F = P4,500.00
r = 6%
t = 2.5 years
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SIMPLE INTEREST (PROBLEM SOLVING)
t = 2.5 years
P4,500.00 = Prt
P4,500.00 = P (0.06)(2.5)
P = P30,000.00

Problem 5. How long must a P40,000.00 note bearing 4% simple interest run to
amount to P41,350.00?
P = P40,000.00
F = P41,350.00
r = 4%
P41,350.00 = P40,000.00 (1 + 0.04t)
t = 0.844 = 303.75 days or 304 days

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SIMPLE INTEREST (SEATWORK)
Problem 1. If P16,000.00 earns P480.00 in 9 months, what is the annual rate of
interest?

Problem 2. A mam lends P6,000.00 at 6% simple interest for 4 years. At the end of this
time he invests the entire amount (principal plus interest) at 5% compounded annually
for 12 years. How much will he have at the end of the 16-year period?

Problem 3. A time deposit of P110,000.00 for 31 days earns P890.39 on maturity date
after deducting the 20% withholding tax on interest income. Find the interest per
annum.

Problem 4. A bank charges 12% simple interest on a P300.00 loan. How much will be
repaid if the loan is paid back in one lump sum after three years?

Problem 5. The tag price of a certain commodity is for 100 days. If paid in 31 days,
there is 3% discount. What is the simple interest paid?

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SIMPLE INTEREST (ANSWERS TO SEATWORK)
Problem 1. If P16,000.00 earns P480.00 in 9 months, what is the annual rate of
interest?
I = Prt; 480 = P16,000r(9/12); r = 0.04 = 4%
Problem 2. A mam lends P6,000.00 at 6% simple interest for 4 years. At the
end of this time he invests the entire amount (principal plus interest) at 5%
compounded annually for 12 years. How much will he have at the end of the
16-year period?
F1 = P6,000(1+(0.06)(4)); F2 = F1 (1 + 0.05)12 = P13,361.17
Problem 3. A time deposit of P110,000.00 for 31 days earns P890.39 on
maturity date after deducting the 20% withholding tax on interest income.
Find the interest per annum.
P = (P890.39/80%) = P1,112.99;
P1,112.99=P110,000.00(r)(31/360);r=11.75%
Problem 4. A bank charges 12% simple interest on a P300.00 loan. How much
will be repaid if the loan is paid back in one lump sum after three years?
F = P300.00(1+(0.12)(3)) = P408.00
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SIMPLE INTEREST (ANSWERS TO SEATWORK)
Problem 5. The tag price of a certain commodity is for 100 days. If paid
in 31 days, there is 3% discount. What is the simple interest paid?
F = P (1+rt)
x = 0.97 x ( 1 + r (69/360))
r = 0.1614 = 16.14%

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COMPOUND INTEREST
In Compound Interest, the interest is computed every end of each interest
period (compounding period), and the interest earned for that period is added
to the principal (interest plus principal).
For example, consider and investment of P1,000 to earn 10% per year for 3
years.
0 1 2 3

P1,000 P1,100 P1,210 P1,331


I = P1,000 x 0.10 I = P1,100 x 0.10 I = P1,210 x 0.10
I = P100 I = P110 I = P121
F=P+I F=P+I F=P+I
F = P1,100 F = P1,210 F = P1,331

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COMPOUND INTEREST
Elements of Compound Interest
P = Present Worth or Principal
F = Future Worth or compound amount
i = effective interest per compounding period (per interest period)
n = number of compoundings
I = Interest earned
r = nominal interest rate
ER = effective interest
t = number of years of investment
m = number of compoundings per year
i = r/m
n=txm
F=P+I

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COMPOUND INTEREST
Future Worth of P
After n periods, the compound amount F is:
F = P (1 + i)n
The term (1 + i)n , also denoted as (F/P, i, n) is called the single
payment compound-amount factor.

Present Worth of F
The present worth of F is:
P = F / (1 + i)n
The term 1 / (1 + i)n, also known as (P/F, I, n) is called the single
payment present worth factor.

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COMPOUND INTEREST
Values of I and n
The following examples show how to get the values of I and n:
Nominal interest rate, r = 12%
Number of years of investment = 5 years
1. Compounded annually (m = 1)
i = 0.12/1 = 0.12
n = 5(1) = 5
2. Compounded semi-annually (m = 2)
i = 0.12/2 = 0.06
n = 5(2) = 10
3. Compounded Quarterly (m = 4)
i = 0.12/4 = 0.03
n = 5(4) = 20
4. Compounded Monthly (m = 12)
i = 0.12/12 = 0.01
n = 5(12) = 60
5. Compounded bi-monthly (m = 6)
i = 0.12/6 = 0.02
06/07/2018 Interest,
n = 5(6) = 30 Simple Interest, Compound Interest 16
COMPOUND INTEREST
Continuous Compounding (m = Ꝏ)
Interest may be compounded daily, hourly, per minute and etc. As a
limit, interest may be considered to be compounded an infinite
number of times per year (m = Ꝏ).

The future worth of P at an interest rate of r compounded


continuously for t years is:
F = Pert

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COMPOUND INTEREST
Nominal and Effective Rates of Interest
Nominal rate is the rate quoted in describing a given variety of
compound interest.
Consider a bank deposit of P1,000.00 to earn 6% compounded
quarterly. After one year, the compound amount F is:
F = P (1 + i)n = P1,000.00(1 + 0.06/4)1 x 4
F = P1,061.36
Notice that the interest earned is P61.36 representing 6.136% of
P1,000.00 (not 6% of P1,000.00). For this case, 6% (compounded
quarterly) is called the nominal rate and 6.136% is the effective rate.
Thus the effective rate of interest (ER) is the actual interest earned in
one year period. This can be computed by either of the following:
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑒𝑑 𝑖𝑛 𝑂𝑛𝑒 𝑌𝑒𝑎𝑟
ER =
𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑎𝑡 𝑡ℎ𝑒 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑜𝑓 𝑡ℎ𝑎𝑡 𝑦𝑒𝑎𝑟
𝒓 𝒎
𝑬𝑹 = (1 + ) −𝟏
𝒎

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COMPOUND INTEREST
Nominal and Effective Rates of Interest
Thus the effective rate of 6% compounded quarterly is,
ER = (1+0.006/4)4 – 1 = 0.06136 or 6.136% as computed previously.

The effective rate of r (%) compounded continuously is:


ER = er - 1

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COMPOUND INTEREST (PROBLEM SOLVING)
1. Accumulate P5,000.00 for 10 years at 8% compounded quarterly.
Compounded quarterly (m = 4), i = 0.08 / 4 = 0.02, n = 10 x 4 = 40
P = P5,000.00
F = P5,000.00 ( 1 + 0.002)40
F = P11,040.20

2. How long will it take P1,000.00 to amount to P1,346.00 if invested at 6%


compounded quarterly?
Compounded quarterly (m = 4), i = 0.06 / 4 = 0.015, n = t x 4
P1,346.00 = P1,000.00 ( 1 + 0.015)t x 4
1.015t x 4 = 1.346
(t x 4) ln 1.015 = ln 1.346
t = 4.99 years or 5 years

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COMPOUND INTEREST (PROBLEM SOLVING)
3. How long will it take for an investment to double its amount if invested at an
interest rate of 6% compounded bi-monthly?
Bi-monthly (m = 6), i = 0.06 / 6 = 0.01, n = t x 6
2P = P ( 1 + 0.01)t x 6
1.01t x 6 = 2
(t x 6) ln 1.01 = ln 2
t = 11.61 years

4. What interest compounded monthly is equivalent to an interest rate of 14%


compounded quarterly?
ERmonthly = ERquarterly
𝑟 12 0.14 4
(1 + ) −1 = (1 + ) −1
12 4
r = 0.1384 = 13.84%

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COMPOUND INTEREST (PROBLEM SOLVING)
5. A firm borrows P2,000.00 for 6 years at 8%. At the end of 6 years, it renews
the loan for the amount due plus P2,000.00 more for 2 years at 8%. What is
the lump sum due?
Annually (m = 1), i = 0.08 / 1 = 0.08, n = 8 x 1 = 8
P1 = P2,000.00
F1 = P2,000.00 (1 + 0.008)6
F1 = P3,173.75
P2 = P3,173.75 + P2,000.00 = P5,173.75
F2 = P5,173.75 (1 + 0.008)2
F2 = P6,034.66

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COMPOUND INTEREST (SEATWORK)
1. The salary of Mr. Cruz is increased by 30% every 2 years beginning January 1,
1982. counting from that date, at what year will his salary just exceed twice his
original salary?

2. What is the effective rate for an interest rate 12% compounded


continuously?

3. How long will it take for an investment to fivefold its amount if money is
worth 14% compounded semi-annually?

4. A sum of P1,000.00 is invested now and left for eight years, at which time
the principal is withdrawn. The interest that has accrued is left for another
eight years. If the effective annual interest rate is 5%, what will be the
withdrawal amount at the end of the 16th year?

5. Convert 12% compounded semi-annually to x% compounded quarterly.


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COMPOUND INTEREST (ANSWER TO SEATWORK)
1. The salary of Mr. Cruz is increased by 30% every 2 years beginning January 1,
1982. counting from that date, at what year will his salary just exceed twice his
original salary?
Let P be the original salary (1982)
F = P (1 + i)n
2P = P (1 + 0.3)n
n ln 1.30 = ln 2
n = 2.64 say 3
Therefore, total number of years after is 3(2) = 6 years

2. What is the effective rate for an interest rate 12% compounded


continuously?
ER = er – 1
ER = 0.1275
ER = 12.75%

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COMPOUND INTEREST (SEATWORK)
3. How long will it take for an investment to fivefold its amount if money is
worth 14% compounded semi-annually?
Semi-annually (m = 2), i = 0.14 / 2 = 0.07, n = t x 2 = 2t
F = P (1 + i)n, F = 5P
5P = P (1 + 0.07)2t
5 = 1.072n
2n ln 1.07 = ln 5
n = 11.89 years say 12 years
4. A sum of P1,000.00 is invested now and left for eight years, at which time
the principal is withdrawn. The interest that has accrued is left for another
eight years. If the effective annual interest rate is 5%, what will be the
withdrawal amount at the end of the 16th year?
F8 = P1,000.00 (1 + 0.05)8 = P1,477.46; P8 = P477.46
F16 = P477.46 (1 + 0.05)8 = P705.42

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COMPOUND INTEREST (SEATWORK)
5. Convert 12% compounded semi-annually to x% compounded quarterly.
ERquarterly = Ersemi-annually
𝑟 0.12 2
(1 + )4 −1 = (1 + ) −1
4 2
r = 0.1183 = 11.83%

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