SIMPLE AND COMPOUND INTERESTS

Part I: Simple Interests

Discussion:

1) Simple Interest – the interest is calculated only once for the entire rate of the loan. In this case,
the interest to be paid is directly proportional to the length of time the amount or principal is
borrowed.
a) Interest
i. From the Borrower’s Viewpoint: It is the amount of money paid for the use of
borrowed capital.
ii. From the Lender’s Viewpoint: It is the income by the money which was lent.
b) Principal – the amount invested or borrowed.
c) Rate – the amount earned by one unit of principal during a unit of time, usually expressed
in percent.
d) Time – time or term of the loan, in years.

𝑰 = 𝑷𝒓𝒕

I Interest
P Principal
r Rate
t Time

2) Future Value – the total amount to be repaid, which is equal to the sum of the principal and the
total interest.

𝑭=𝑷+𝑰

𝑭 = 𝑷 + (𝑷𝒓𝒕)

𝑭 = 𝑷(𝟏 + 𝒓𝒕)

Examples:

1) Steve invested $10,000 in a savings bank account that earned 2% simple interest. Find the interest
earned if the amount was kept in the bank for 4 years.
2) A total of $20,000 is invested. Part of it is at 6%, and part of it is at 6.5%. The total interest after
one year is $1,260. How much was invested at each rate?
3) A student purchases a computer by obtaining a simple interest loan. The computer costs $1,500,
and the interest rate on the loan is 12%. The loan is to be paid back in weekly installments after 2
years.
a) Calculate the amount of interest paid over the 2 years.
b) Calculate the total amount to be paid back.
c) Calculate the weekly payment amount.
4) In how much time will the simple interest on $3,500 at the rate of 9% per annum be the same as
the simple interest on $4,000 at 10.5% per annum for 4 years?
Part II: Ordinary and Exact Simple Interests

Discussion:

1) Ordinary Interest (Banker’s Rule) – calculated on the basis of a 360-day year or a 30-day month.

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒂 𝑳𝒐𝒂𝒏 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔

𝑰𝑶 = = 𝑷𝒓 ( )
𝟑𝟔𝟎 𝟑𝟔𝟎

2) Exact Interest – calculated on the basis of a 365-day year for an ordinary year and 366 days for a
leap year. (NOTE: Leap years are those which are exactly divisible by 4. For century years,
it has to be divisible by 400.)

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒂 𝑳𝒐𝒂𝒏 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔

𝑰𝑬 = = 𝑷𝒓 ( ) for Ordinary Year
𝟑𝟔𝟓 𝟑𝟔𝟓

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒂 𝑳𝒐𝒂𝒏 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑫𝒂𝒚𝒔

𝑰𝑬 = = 𝑷𝒓 ( ) for Leap Year
𝟑𝟔𝟔 𝟑𝟔𝟔

Examples:

1) On January 15, 2017, a businessman loans P15,000 in the bank for the expansion of his restaurant.
It was agreed that he will pay the amount with 6% simple interest rate on June 20, 2017.
a) What is the ordinary simple interest amount?
b) What is the exact simple interest amount?
2) Emily borrowed P1,200 from her dad, which started on June 16, 2016. If the loan ended on
February 26, 2017 with an exact simple interest of 24%, what was the total amount that Emily had
to pay?
3) A man borrows P6,400 from a loan association. In repaying this debt, he has to pay P400 at the
end of every three months on the principal, and a simple interest of 16% on the principal outstanding
at that time. Determine the total amount he has paid after paying all his debt.

Part III: Discount

Discussion:

1) Discount – the difference between what it is worth in the future and its present worth.

𝑷=𝑭−𝑫

𝑫 = 𝑭𝒅𝑻

𝑷 = 𝑭(𝟏 − 𝒅𝑻)

D Discount Amount
F Future / Face Value
d Discount Rate
T Time
 2) Rate of Discount (𝒅) – the discount on one unit of principal per unit of time.

𝒅
𝒓=
𝟏−𝒅

Examples:

1) A bank charges a simple discount rate of 10% per annum for a note due in 6 months. Calculate the
future value of the note if the amount of the discount is $50.
2) A certain bill is maturing with a face value of P15,670 and discount amount of P4,433.58. Assume
the discount rate to be at 11.74% per annum.
a) Calculate the maturity of this bill in months.
b) Calculate the present value.
3) Joseph borrows an amount that has a face value of P10,000 from a loan firm. The rate of simple
interest is 15%, but the interest is to be deducted from the loan at the time the money is borrowed.
At the end of one year, he has to pay back P10,000. What is the actual rate of interest?

Part IV: Compound Interests

Discussion:

1) Compound Interest – the interest is calculated more than once during the time period of the loan.
When compound interest is applied to a loan, each succeeding time period accumulates interest
on the previous interest, in addition to interest on the principal.

𝑰= 𝑭−𝑷

I Compound Interest
F Future Value
P Principal

2) Compound Amount (Future Value) – the total amount of principal and accumulated interest at
the end of a loan or investment. In the formula, (𝟏 + 𝒊)𝒏 is called the Single Payment Compound
Amount Factor.

𝑭 = 𝑷(𝟏 + 𝒊)𝒏
𝒊
NOTE: 𝒊 = 𝒏, where 𝒊𝒏 is the nominal rate of interest (rate that is normally specified for
𝒎
compound interests, which indicates the rate of interest and the number of periods per
year). Additionally, 𝒏 = 𝒎𝒕.

EXAMPLE: A nominal interest of “8% compounded quarterly” means that there are 4
periods each year, the rate per period being 𝟎. 𝟎𝟖⁄𝟒 = 𝟎. 𝟎𝟐. In this case, 𝒊 = 𝟎. 𝟎𝟐.
Therefore:

𝒊𝒏 𝒎𝒕
𝑭 = 𝑷( )
𝒎
 TIME PERIOD 𝒏
Annually 1
Semi-Annually 2
Weekly 52
Monthly 12
Bimonthly 6
Quarterly 4

3) Present Value – the amount of money that must be deposited today at compound interest to
provide a specified lump sum of money in the future.
4) Effective Rate of Interest / Annual Percentage Yield – the actual rate of interest on the principal
for one year. (NOTE: The formula below has a basis of one year.)
a) If the nominal rate of interest is compounded annually, 𝑖𝑛 = 𝑖𝑒𝑓𝑓 .
b) If the nominal rate of interest is compounded semi-annually, quarterly, or monthly, 𝑖𝑛 <
𝑖𝑒𝑓𝑓 .

𝒊𝒏 𝒎
𝒊𝒆𝒇𝒇 = (𝟏 + ) −𝟏
𝒎

Examples:

1) If you deposit $5,000 into an account paying 6% annual interest compounded monthly, how long
until there is $8,000 in the account?
2) John invested $1,200 in an account at 8% interest, compounded quarterly for 5 years.
a) What is the compound amount?
b) What is the amount of the compound interest?
3) At a certain interest rate compounded quarterly, P1,000 will amount to P4,500 in 15 years.
a) What is the nominal interest rate?
b) What is the amount at the end of 10 years?
4) What payment 𝑥 ten years from now is equivalent to a payment of P1,000 six years from now, if
interest is 15% compounded:
a) annually?
b) monthly?
5) An amount of P2,000 becomes P3,524.58 after 5 years when invested at an unknown rate of
interest compounded bimonthly.
a) What is the unknown nominal rate?
b) What is the corresponding effective rate?
Part V: Cash-Flow Diagrams and Equation of Value

Discussion:

1) Cash-Flow Diagram – a graphical representation of cash flows drawn on a time scale.

a) Upward Arrow – used for positive cash flow or cash inflow.
b) Downward Arrow – used for negative cash flow or cash outflow.
2) Equation of Value – obtained by setting the sum of the values on a certain comparison or focal
date of one set of obligations equal to the sum of the values on the same date of another set of
obligations.

Examples:

1) Annual deposits were made in a fund earning 10% per annum. The first deposit was P2,000, and
each deposit thereafter was P200 less than the preceding one. Determine the amount in the fund
after the sixth deposit.
2) A man wishes to bequeath to his daughter P20,000 ten years from now. What amount should he
invest now if it will earn 8% compounded annually during the first 5 years, and 12% compounded
quarterly during the next 5 years?
3) A company expects to retire an existing machine at the end of 2020, and will replace it with a new
machine for the same task at an estimated cost of P60,000. The old machine is expected to be
sold for P5,000 when it is replaced. To provide for replacement, the company intends to deposit
the following amounts in an account earning interest at 8% compounded quarterly: P20,000 at the
end of 2017; P15,000 at the end of 2018; and P10,000 at the end of 2019. What additional amount
is needed at the end of 2020 to purchase the new machine?