SIMPLE AND COMPOUND

INTEREST

Ryan Jeffrey P Curbano, CIE, PIE, MSc

Industrial Engineering Department
 Learning Objectives
• Perform calculations about interest rates.
• Calculate simple interest and compound
interest for one or more interest period.
 INTEREST
• Interest – is the amount or money paid
for the use of borrowed capital.
– For the lender, interest is the income
produced by the money which he has lent.
• Simple Interest – interest on the
borrowed money, if the interest to be paid
is directly proportional to the length of
time the amount or principal is borrowed.
• Principal – is the amount of money
borrowed and on which interest is
charged.
• Rate of Interest – is the amount earned
by one unit of principal during a unit of
time.
 Formula of Simple Interest

I = Pin
Where: I = total interest earned by the
principal.
P = amount of the principal
i = rate of interest expressed in
decimal form.
n = number of interest period.
• Total amount F to be repaid at the end of
the period
• Formula:
F=P+I
= P(1 + in)
 Ordinary Simple Interest

• Ordinary simple interest – is computed

on the basis of one banker’s year, which is
1 banker’s year = 12 months, each
consisting of 30 days.
= 360 days
 Exact Simple Interest
• Exact simple interest – is based on the
exact number of days, 365 for the
ordinary year and 366 days for the
leap year. The leap year are those
which are exactly divisible by 4 but
excluding the century years such as
the years 1900, 2000
 Formulas
• Ordinary Simple Interest
I = Pi (d/360)
• Exact Simple Interest
I = Pi(d/365) – ordinary year
I = Pi(d/366) – leap year
Where: d – is number of days
 Example 1.0
• Determine the ordinary simple interest on
P10,000 for 9 months and 10 days if the
rate of interest is 12%
 Example 2.0
• Determine the ordinary and exact interest
simple interest on P5,000 for the period
from Jan 15 to June 20, 1993, if the rate of
simple interest is 14%
 Example 3.0
• Determine the exact and ordinary simple
interest on P1,200 for the period from Jan
16 to Nov. 26, 1992, if the rate of interest
is 24%. Note the year 1992 is a leap year.
 Example 4.0
• A P4,000 is borrowed for 75 days at 16%
per annum simple interest. How much will
be due at the end of 75 days?
 Example 5.0
• A man deposit P 100,000 for one year
which pays 6% interest annually. He has a
taxable income and the bank charges a
withholding tax of 20% incremental income
tax rate. Compute the after tax rate of
return of his deposit.
 Compound Interest
• Compound interest – interest earned by
the principal is not paid at the end of each
interest period, but is considered as added
to the principal and therefore will also earn
interest for the succeeding period
– Interest is much more than that earned by the
same principal when invested at simple
interest for the same period
 Formulas
• Compound Interest, total amount paid at
the end of n period
n
F = P(1+i)
n
The factor (1+i) is called the “Single Payment
Compound Amount Factor” designated by
SPCAF = (F/P, i%, n)
 Derivation of Formula of Future
Amount
Period Principa Interest Total Amount (Future)
l
1 P Pi P + Pi = P(1+i)
2 P(1+i) P(1+i) i P(1+i) + P(1+i) =
P(1+i)²
3 P(1+i) ² P (1+i)² i P(1+i)²(1+i) = P(1+i)³
N P(1+i)ⁿ
• If r is the nominal annual interest rate and m
is the number of interest periods each year,
then the interest rate per interest period is
i = r/m, and the number of interest periods in
n years is mn
• Formula: Single payment compound amount
factor
mn
F = P(1 + r/m)
 Continuous Compounding
• The number of interest period per year
without limit.
• Formula:
rn
F = Pe
where: e is the base of natural logarithm
 Nominal Rate of Interest
• For the compound interest, the rate of
interest usually quoted is nominal rate if
interest which specifies the rate of interest
and the number of interest periods per
year.
• Example: a nominal rate of interest
compounded 8% quarterly, which means
rate per period is 8%/4 = 0.02
 Effective Rate of Interest
• It is the actual rate of interest on the
principal for one year.
• It is equal to the nominal rate is interest is
compounded annually
• Greater than nominal rate if the number of
interest period per year exceeds one, such
as for interest compounded semi-annually,
quarterly or monthly
 Formula
• Effective rate of interest
m
ER = (1 +i/m) - 1
 Present Value
• Present value (P) is the amount which
when invested now will become F after n
periods.
• Formula:
P = F(1 + i) - n or
= F or
n
(1+i)
= F(P/F, i%, n)
 Discount
• Discount on the negotiable paper is the
difference between what it is worth in the
future and its present worth.
Discount = Future value – Present value
• Rate of discount (d)– is the discount on
one unit of principal per unit of time
 DISCOUNT Formulas
• Rate of Discount (d)

d=1- 1 or i
1+i (1 + i)
• Rate of Interest given the discount
I= d
(1- d)
 Example 1.0
• Find the present worth of the future
payment P300,000 to be made in 5 years
with an interest rate of 8% per annum
 Example 2.0
• At certain interest rate compounded
quarterly, P1,000 will amount to P4,500 in
15 years. What is the amount at the end of
10 years?
 Example 3.0
• Calculate the effective rate of interest
corresponding to each of the following
rates.
– 9% compounded semi-annually
– 9% compounded quarterly
– 9% compounded bi-monthly
– 9% compounded monthly
– 9% compounded continously
 Example 4.0
• An advertisement of an investment firm
states that if you invest P500 in their firm
today you will get P1,000 at the end of 4.5
years. What nominal rate is implied if
interest is compounded (a) quarterly (b)
monthly? Determine also the effective rate
of interest in each case.
 Example 5.0
• The present worth of several cash payments may be
define as the sum of the values of the future cash
payment discounted at a given rate for the
corresponding period to the present. Find the present
value of installment payment of P1,000 now, P2,000 at
the end of 1st year, P3,000 at the end of 2nd year,
P4,000 at the end of 3rd year and P5,000 at the end of
4th year. Money is worth 10% compounded annually.
 Example 6.0
• How many years are required for P1,000
to increase to P2,000 if invested at 9% per
year compounded (a) daily (b)
continuously (c) monthly
 Example 7.0
• A man borrows money from the bank
which uses a simple discount rate of 14%.
He signs a promissory note promising to
pay P500 per month at the end of 4th, 6th
and 7th month respectively. Determine the
amount of money that he received from
the bank?
 Example 8.0
• Find the discount if P2,000 is discounted
for 6 months at 8% compounded quarterly.
 Example 9.0
• A nominal interest of 3% compounded
continuously is given on the account. What
is the accumulated amount of P10,000
after 10 years?
 Seatwork
• When will an amount be tripled with an interest
of 11.56%
• If P 5000 shall accumulate for 10 years at 8%
compounded quarterly. Find the compounded
interest at the end of 10 years
• P2000 was deposited on January 1, 1988 at an
interest rate of 24% compounded semi annually
How much would the sum be on Jan 1, 1993
• Convert 12% compounded semiannually to a
rate of compounded quarterly