9.

2 Interest
Objectives
1. Understand the simple interest formula.
2. Use the compound interest formula to find future value.
3. Solve the compound interest formula for different unknowns, such as the present
value, length, and interest rate of a loan.

The most powerful force in the universe is. . . .

How would you finish this quote? The world-renowned physicist Albert Einstein said,
. . . compound interest.
Are you surprised that of all the forces that he might pick, Einstein chose this one? In this
section, we will explain how interest can either work for you—or against you. As you will
see, used properly, it can help you build a fortune; used improperly, it can lead you to
financial ruin.
If you want to accumulate enough money to buy a newer car or go on a vacation, you
could deposit money in a bank account. The bank will use your money to make loans to
other customers and pay you interest for using your funds. However, if you borrow money
from the bank, say to take a college course, then you will pay interest to the bank. In
essence, interest is the money that one person (a borrower) pays to another (a lender) to
use the lender’s money. Savers earn interest; borrowers pay interest.
We will discuss simple and compound interest in this section, and discuss the cost of
consumer loans in Section 9.3.

KEY POINT Simple Interest*

Simple interest is a The amount you deposit in a bank account is called the principal. The bank specifies an
straightforward way to interest rate for that account as a percentage of your deposit. The rate is usually expressed
compute interest.
as an annual rate. For example, a bank may offer an account that has an annual interest rate
of 5%. To find the interest that you will earn in such an account, you also need to know
how long the deposit will remain in the account. The time is usually stated in years. There
is a simple formula that relates principal, interest earned, interest rate, and time. In words,
interest earned = principal * interest rate * time.
When we compute interest this way, it is called simple interest.

F O R M U L A F O R C O M P U T I N G S I M P L E I N T E R E S T We calculate simple inter-

est using the formula
I = Prt,
where I is the interest earned, P is the principal, r is the interest rate, and t is the time in
years.

*If you want some practice with basic algebra, see Appendix A.

Copyright © 2010 Pearson Education, Inc.

 9.2 y Interest 405

EXAMPLE 1 Calculating Simple Interest

If you deposit $500 in a bank account paying 6% annual interest, how much interest
will the deposit earn in 4 years if the bank computes the interest using simple interest?
SOLUTION: In this example:

P is the principal, which is $500

r is the annual interest rate, which is 6% (written as 0.06)
t is the time, which is 4 (years)
Thus, the interest earned is
I = Prt = 500 * 0.06 * 4 = 120.
In 4 years, this account earns $120 in interest.
Now try Exercises 5 to 8. ]

KEY POINT To find the amount that will be in your account at some time in the future, called the
Future value equals principal future value (or sometimes called the future amount) we add the principal and the inter-
plus interest. est earned. We will represent future value by A, so we can say
A = principal + interest = P + I.
If we replace I by Prt, we get the formula A = P + Prt = P(1 + rt).

C O M P U T I N G F U T U R E V A L U E U S I N G S I M P L E I N T E R E S T To find the
future value of an account that pays simple interest, use the formula
A = P (1 + rt ),
where A is the future value, P is the principal, r is the annual interest rate, and t is the
time in years.

EXAMPLE 2 Computing Future Value Using Simple Interest

Assume that you deposit $1,000 in a bank account paying 3% annual interest and leave the
money there for 6 years. Use the simple interest formula to compute the future value of this
account.
SOLUTION: We see that P = 1,000, r = 0.03, and t = 6. Therefore,

P r t
A  1,000(1  (0.03)(6))  1,000(1  0.18)  1,000(1.18)  1,180.
Thus, your bank account will have $1,180 at the end of 6 years. ]

In contrast to future value, the principal that you have to invest in an account now to
have a specified amount in the account in the future is called the present value of the
account. Notice that the formula for computing future value has four unknowns. If we
want, we can use this formula for finding the present value of an account provided
we know the future value, interest rate, and time.

EXAMPLE 3 Finding the Present Value of an Account

Assume that you plan to save $2,500 to take a white-water rafting trip in Costa Rica in
2 years. Your bank offers a certificate of deposit (CD) that pays 4% annual interest com-
puted using simple interest. How much must you put in this CD now to have the necessary
money in 2 years?

Copyright © 2010 Pearson Education, Inc.

406 CHAPTER 9 y Consumer Mathematics
Quiz Yourself 5 Dividing both sides of the equation by 1.08, we get
Redo Example 3, but now
assume that you want to save
$2,400 in 4 years and the
CD has an annual interest rate
of 5%.
KEY POINT
Compounding pays interest
on previously earned
interest.
Quiz Yourself 6
Continue Example 4 to calculate
the amount in your account at the
end of the fourth year.
SOLUTION: We can use the formula
A = P(1 + rt).
We know that A = 2,500, r = 4% = 0.04, and t = 2. Therefore,
2,500 = P(1 + (0.04)(2)).
We can rewrite this equation as
2,500 = P(1.08).
2,500
P= L 2314.814815.
1.08
We will round this up to $2,314.82 to guarantee that if you put this amount in the
CD now, in 2 years you will have the $2,500 you need for your white-water rafting trip.*
Now try Exercises 9 to 14. ] 5
› Some Good Advice
In Example 3, we used the earlier formula for computing future value to find the present value
rather than stating a new formula to solve this specific problem. You will find it easier to learn
a few formulas well and use them, together with simple algebra, to solve new problems rather
than trying to memorize separate formulas for every type of problem.
Compound Interest
It seems fair that if money in a bank account has earned interest, the bank should compute
the interest due, add it to the principal, and then pay interest on this new, larger amount. This
is in fact the way most bank accounts work. Interest that is paid on principal plus previously
earned interest is called compound interest. If the interest is added yearly, we say that
the interest is compounded annually. If the interest is added every three months, we say the
interest is compounded quarterly. Interest also can be compounded monthly and daily.
EXAMPLE 4 Calculating Compound Interest the Long Way
Assume that you want to replace your sailboat with a larger one in 3 years. To save for a
down payment for this purchase, you deposit $2,000 for 3 years in a bank account that pays
10% annual interest,† compounded annually. How much will be in the account at the end
of 3 years?
S O LU T I O N : We will perform the compound interest calculations one year at a time in
the following table. In compounding the interest, we will use the future value from the
previous year as the new principal at the beginning of the year. Notice that the quantity
(1 + rt) = (1 + 0.10 * 1) = (1.10) remains the same throughout the computations.
Principal (Beginning of Year) Future Value (End of Year)
Year P P(1 + rt) = P(1.10)
1 $2,000 $2,000(1.10) = $2,200
2 $2,200 $2,200(1.10) = $2,420
3 $2,420 $2,420(1.10) = $2,662 ] 6
*When calculating a deposit to accumulate a future amount, we will always round up to the next cent.
†An interest rate of 10% would be extraordinarily high. However, we will often choose rates in examples and
exercises to keep the computations simple.
Copyright © 2010 Pearson Education, Inc.

Quiz Yourself 7 have in the future
Calculate the future value of an
account containing $3,000 for
which the annual interest rate is
4% compounded annually for
10 years.
KEY POINT
Knowing the principal, the
periodic interest rate, and
the number of compounding
periods, it is easy to
determine future value.
9.2 y Interest 407
PROBLEM SOLVING
Verify Your Answer
You should always check answers to see whether they are reasonable. In Example 4, if we had
used simple interest to find the future value, we would have obtained A = 2,000
(1 + (0.10)(3)) = 2,000(1.30) = 2,600. The interest we found in Example 4 is a little larger
because as the interest is added to the principal each year, the bank is paying interest on an
increasingly larger principal.
If we were to continue the process that we used in Example 4 for a longer period of time,
say for 30 years, it would be very tedious. In Figure 9.2 we look at the same computations in
a different way, keeping in mind that the amount in the account at the end of each year is 1.10
times the amount in the account at the beginning of the year.
Amount in account is Amount in account is Amount in account is
$2,000  (1.10)  $2,000  (1.10)  (1.10)  $2,000  (1.10)  (1.10)  (1.10) 
$2,000  (1.10)1 $2,000  (1.10)2 $2,000  (1.10)3
0 1 2 3
You deposit $2,000 End of year 1 End of year 2 End of year 3
at the beginning of
year 1.
FIGURE 9.2 10% interest being compounded annually.
If we were to continue the pattern shown in Figure 9.2 to compute the future value of
the account at the end of 30 years, we would see that
A = 2,000(1.10)30 L 2,000(17.44940227) L 34,898.80. *
This large amount shows how your money can grow if it is compounded over a long period
of time.
In general, if we deposit a principal P in an account paying an annual interest rate r for
t years, then the future value of the account is given by the formula
money you will
money you have now
A  P(1  r)t.
In the example that we just calculated, P = 2,000, r = 0.10, and t = 30. It is important to
understand that this formula for calculating compound interest only works for the case when
r is the annual interest rate and t is time being measured in years. Do not bother to learn this
formula because in just a moment we will give you a similar compounding formula that
works for more general situations. 7
Solving for Unknowns in the Compound Interest Formula
All banks and most other financial institutions compound interest more frequently than once
a year. For example, many banks send savings account customers a monthly statement
showing the balance in their accounts. So far in our discussion of compounding, we have
used a yearly interest rate. If compounding takes place more frequently, then the interest
rate must be adjusted accordingly. For example, a yearly interest rate of 12% = 0.12
*To ensure greater accuracy, we often show calculations with eight decimal places. If your calculations do not
agree with ours, it may be due to the difference in the way we are rounding our calculations.
Copyright © 2010 Pearson Education, Inc.
408 CHAPTER 9 y Consumer Mathematics

corresponds to a monthly interest rate of 12% 0.12

12 = 12 = 0.01 = 1%. If the interest is being
compounded quarterly, the quarterly interest rate would then be 12% 0.12
4 = 4 = 0.03 = 3%.
In order to handle situations such as these, we will modify the formula A = P(1 + r)t
slightly.

T H E C O M P O U N D I N T E R E S T F O R M U L A Assume that an account with

principal P is paying an annual interest rate r and compounding is being done m times
per year. If the money remains in the account for n time periods, then the future
value, A, of the account is given by the formula
r n
A = P a1 + b.
m
r
Notice that in this formula, we have replaced r by m , which is the annual rate divided by
the number of compounding periods per year, and t by n, which is the number of com-
pounding periods.

You can use the compound interest formula for computing compound interest to
compare investments.

EXAMPLE 5 Understanding How “No Payments

Quiz Yourself 8 Therefore,
Sarah deposits $1,000 in a CD
paying 6% annual interest for
2 years. What is the future value
of her account if the interest is
compounded quarterly?
Until . . .” Works
You have seen a home fitness center on sale for $3,500 and what really makes the deal
attractive is that there is no money down and no payments due for 6 months. Realize that
although you do not have to make any payments, the dealer is not loaning you the money
for 6 months for nothing. You have borrowed $3,500 and, in 6 months, your payments
will be based upon that fact. Assuming that your dealer is charging an annual interest
rate of 12%, compounded monthly, what interest will accumulate on your purchase over
the next 6 months?
SOLUTION: To determine the interest that has accumulated, we will find the future value of
your “loan” (assuming that you make no payments) and subtract $3,500 from that. We will
use the formula for calculating future value with P = 3,500, r = 0.12, m = 12, and n = 6.
monthly interest rate number of months
     3,500(1.01)  3,715.33.
n 6
r 0.12
AP 1  3,500 1  6
m 12
So the accumulated interest is $3,715.33 - $3,500 = $215.33.
Now try Exercises 19 to 26. ] 8

¶ ¶ ¶ HIGHLIGHT
Between the Numbers—It Doesn’t Hurt to Ask
In Example 5, you might ask yourself if you would be
better off borrowing the $3,500 from another source that has
a lower interest rate and paying for the fitness center
outright.
If you have the money, sometimes a dealer might give
you a better price if you offer to pay for an item with cash.
The trick, of course, is to be able to put money aside so that
when you want to make a deal, you are not at the mercy of
someone else’s money.

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 9.2 y Interest 409

Doing Financial Calculations with a Calculator*
When doing financial computations, often technology can
speed up your work. We will use a calculator to reproduce
the solution to Example 6.
On my calculator, if we press the  2nd   Finance  keys,
Screen 1 comes up. The letters TVM stand for “Time Value of
Money.” Then by choosing option 1, we get Screen 2. Now we
can enter the values 18 for N, the number of years; 4.8 for I%,
HIGHLIGHT ¶ ¶ ¶
the annual interest rate; 60,000 for FV, the future value; and 4
for C/Y, the number of compounding periods per year. Next
we position the cursor over PV (present value) and press the
keys  Alpha   Solve  . The amount -25418.75939 for
present value means that we must deposit $25,418.76 now
to have the desired $60,000 in 18 years (Screen 3).

Screen 1 Screen 2 Screen 3

Example 6 illustrates a different way to use the compound interest formula.

EXAMPLE 6 Finding the Present Value for a College

KEY POINT
We use the log function to
solve for n in the formula
n functions enables you to solve such equations. Many calculators have a key labeled either
A = P A 1 + mr B .
Tuition Account
Upon the birth of a child, a parent wants to make a deposit into a tax-free account to use
later for the child’s college education. Assume that the account has an annual interest rate
of 4.8% and that the compounding is done quarterly. How much must the parent deposit
now so that the child will have $60,000 at age 18?
r n
S O L U T I O N : We will use the compound interest formula A = P A 1 + m B . Because we
know A = 60,000, r = 0.048, n = 72, and m = 4, we can find the present value by solving the
equation
0.048 72
60,000 = Pa1 + b = P11 + 0.012272
4
for P. Therefore,
60,000 60,000
P= 72
= L 25,418.76.
(1.012) 2.360461386
A deposit slightly over $25,400 now will guarantee $60,000 for college in 18 years.
Now try Exercises 33 and 34. ]
Although $60,000 may seem like a lot of money, realize that inflation, the increase in
the price of goods and services, will also cause the cost of a college education to increase.
We will consider the effects of inflation in the exercises.
r n
So far we have used the formula A = P A 1 + m B to find A and P. Sometimes we want to find
r or n. To do this, we need to introduce some new techniques.
n
If you want to solve for n in the formula A = P A 1 + mr B , you need to be able to solve an
equation of the form ax = b, where a and b are fixed numbers. A property of logarithmic
“log” or “log x,” which stands for the common logarithmic function. Pressing this key

*For this example, I am using a TI-83 calculator, but many other calculators have similar features for doing financial
calculations. On the TI-83 plus and TI-84, press the  APPS  key and then choose option 1 to get screen 1.

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410 CHAPTER 9 y Consumer Mathematics

reverses the operation of raising 10 to a power. For example, suppose that you compute
105 = 100,000 on your calculator. If you next press the log key, the display will show 5. If
you enter 1,000, which is 10 raised to the third power, and press the log key, the display
will show 3. Practice finding the log of powers of 10 such as 100 and 1,000,000. If you
enter 23 and then press the log key, the display will show 1.361727836. The interpretation
of this result is that 101.361727836 = 23.* The log function has an important property that
will help us solve equations of the form ax = b.

EXPONENT PROPERTY OF THE LOG FUNCTION

log y x = x log y

To understand this property, you should use your calculator to verify the following:
log 45 = 5 log 4
log 63 = 3 log 6
Example 7 illustrates how to use the exponent property to solve equations.

EXAMPLE 7 Solving an Equation Using the Exponent

Property of the Log Function
Solve 3x = 20.
SOLUTION: We illustrate the steps required to solve this equation.

Step 1 Take the log of both sides of the equation. log 3x = log 20
Step 2 Use the exponent property of the log function. x log 3 = log 20
log 20
Step 3 Divide both sides by log 3. x=
log 3
Step 4 Use a calculator to evaluate the right side of x = 2.726833028
the equation (your calculator may give a
Quiz Yourself 9 slightly different answer).

Solve 6x = 15.
Now try Exercises 35 to 42. ] 9

In Example 8, we use the exponent property of the log function to find the time it takes
an investment to grow to a certain amount.

EXAMPLE 8 Saving for Equipment for a Business

Mara wants to buy lighting equipment from her cousin to start a dance studio. He will sell
his equipment for $2,800. She presently has $2,500 and found an investment that will pay
her 9% annual interest, compounded monthly. In how many months will Mara be able to
pay her cousin for the equipment?
SOLUTION: We know that the future value that Mara must pay her cousin is A = 2,800. She
presently has $2,500 and the monthly interest rate is mr = 0.09
12 = 0.0075 . We must solve
n
the compound interest formula A = P A 1 + mr B for n, which represents the number of
months of the compounding. Substituting for A, P, and mr , we get the equation
0.09 n
2,800 = 2,500 a1 + b .
12

*We will not discuss what it means to raise 10 to a power such as 1.361727836.

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 9.2 y Interest 411

We solve this equation by the following steps:

1.12 = (1.0075)n Divide both sides of the
equation by 2,500 and simplify.
log(1.12) = log(1.0075)n Take the log of both sides.
log(1.12) = n log(1.0075) Use the exponent property of
the log function.
Quiz Yourself 10
Solving for n, we get the equation
Do Example 8 again, but now log (1.12)
n= L 15.17.
assume that the interest rate log (1.0075)
is 6%.
This means that Mara will have the money she needs by the end of the 16th month. ] 10

The last situation

n
that we will consider is how to solve the compound interest equation
A = P A 1 + mr B for r. To do this, we have to be able to solve an equation of the form x a = b,
where a and b are fixed numbers. We show how to solve such an equation in Example 9.

EXAMPLE 9 Negotiating a Basketball Contract

Kobe is negotiating a new basketball contract with the Lakers and expects to retire after
playing one more year. In order to reduce his current taxes, his agent has agreed to
defer a bonus of $1.4 million to be paid as $1.68 million in 2 years. If the Lakers invest the
$1.4 million now, what rate of investment would they need to have $1.68 million to pay
Kobe in 2 years? Assume that you want to find an annual interest rate that is compounded
monthly.
S O L U T I O N : nTo solve this compound interest problem, we again use the formula
A = P A 1 + mr B . We know that A = 1.68, P = 1.4, m = 12, and n = 24.
Substituting for A, P, m, and n, we get the equation
r 24
1.68 = 1.4 a1 + b .
12
24
Dividing both sides of the equation by 1.4 gives us 1.2 = A 1 + 12r B . We can get rid of
1
the exponent 24 if we raise both sides of the equation to the 24 power. This gives us the equation
r 24 1/24 r *
(1.2)1/24 = a a1 + b b =1+ .
12 12
Subtracting 1 from both sides of the equation, we get
r
= (1.2)1/24 - 1 = 1.00762566 - 1 = 0.00762566.
12
Now, multiplying this equation by 12, we find the annual interest rate, r, to be
12(0.00762566) L 0.0915. Thus, the Lakers need to find an investment that pays an
annual interest rate of about 9.15% compounded monthly.
Now try Exercises 43 to 46. ]

› Some Good Advice

Be careful to distinguish between the situations in Examples 8 and 9. In Example 8, we used
the log function to solve an equation of the form ax = b. In Example 9, we solved an equation
of the form x a = b by raising both sides of the equation to the 1a power.

*In algebra, (a x ) y = a xy. That is why A A 1 + 12r B 24 B 1/24 = A 1 + 12r B (24)(1/24) = A 1 + 12r B 1 = 1 + 12r .

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412 CHAPTER 9 y Consumer Mathematics

Exercises 9.2
Looking Back* 22. $8,000, 4%, quarterly; 3 years
These exercises follow the general outline of the topics presented in 23. $20,000, 8%, monthly; 2 years
this section and will give you a good overview of the material that 24. $10,000, 6%, monthly; 5 years
you have just studied. 25. $4,000, 10%, daily; 2 years
1. How did we find the present value in Example 3? 26. $6,000, 4%, daily; 3 years
2. Why did we divide the yearly interest rate of 0.12 by 12 in Savings institutions often state two rates in their advertising. One is
Example 5? the nominal yield, which you can think of as an annual simple interest
3. What property of the log function did we use to solve the rate. The other is called the effective annual yield, which is the actual
equation 3x = 20 in Example 7? interest rate that the account earns due to the compounding. If $1,000
4. What was our recommendation in the “Between the Numbers” is in an account that pays a nominal yield of 9% and if the compound-
Highlight following Example 5? ing is done monthly, then after 1 year, the account would contain
$1,093.80, which corresponds to a simple interest rate of 9.38%. We
Sharpening Your Skills would say that this account has an effective annual yield of 9.38%. In
In Exercises 5–8, use the simple interest formula I = Prt and Exercises 27–30, find the effective annual yield for each account.
elementary algebra to find the missing quantities in the table below. 27. nominal yield, 7.5%; compounded monthly
28. nominal yield, 10%; compounded twice a year
I P r t
29. nominal yield, 6%; compounded quarterly
5. $1,000 8% 3 years 30. nominal yield, 8%; compounded daily
6. $196 7% 2 years
In Exercises 31 and 32, you are given an annual interest rate and
7. $700 $3,500 4 years the compounding period for two investments. Decide which is the
8. $1,920 $8,000 6% better investment.
31. 5% compounded yearly; 4.95% compounded quarterly
In Exercises 9–14, use the future value formula A = P(1 + rt) and
32. 4.75% compounded monthly; 4.70% compounded daily
elementary algebra to find the missing quantities in the table below.
In Exercises 33 and 34, Ann and Tom want to establish a fund for
A P r t their grandson’s college education. What lump sum must they
deposit in each account in order to have $30,000 in the fund at the
9. $2,500 8% 3 years
end of 15 years?
10. $1,600 4% 5 years
33. Saving for college. 6% annual interest rate, compounded
11. $1,770 6% 3 years quarterly
12. $2,332 3% 2 years 34. Saving for college. 7.5% annual interest rate, compounded
13. $1,400 $1,250 2 years monthly
14. $966 $840 5% In Exercises 35–42, solve each equation.
35. 3x = 10 36. 2x = 12
In Exercises 15–18, you are given an annual interest rate and the
37. (1.05)x = 2 38. (1.15)x = 3
compounding period. Find the interest rate per compounding period.
39. x3 = 10 40. x2 = 10
15. 18%; monthly 16. 8%; quarterly
41. x4 = 10 42. x4 = 25
17. 12%; daily† 18. 10%; daily
In Exercises 19–26, you are given the principal, the annual interest In Exercises 43–46, use the compound interest formula A = P(1 + r)t
rate, and the compounding period. Use the formula for computing and the given information to solve for either t or r. (We are assuming
future value using compound interest to determine the value of the that n = 1.)
account at the end of the specified time period. 43. A = $2,500, P = $2,000, t = 5
19. $5,000, 5%, yearly; 5 years 44. A = $400, P = $20, t = 35
20. $7,500, 7%, yearly; 6 years 45. A = $1,500, P = $1,000, r = 4%
21. $4,000, 8%, quarterly; 2 years 46. A = $2,500, P = $1,000, r = 6%

*Before doing these exercises, you may find it useful to review the note How to Succeed at Mathematics
on page xix.
†We will assume there are 365 days in a year.

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Applying What You’ve Learned
47. Buying an entertainment system. You have purchased a
home entertainment system for $3,600 and have agreed to pay
off the system in 36 monthly payments of $136 each.
a. What will be the total sum of your payments?
b. What will be the total amount of interest that you have
paid?
48. Buying a car. You have purchased a used car for $6,000 and
have agreed to pay off the car in 24 monthly payments of
$325 each.
a. What will be the total sum of your payments?
b. What will be the total amount of interest that you have
paid?
Often, through government-supported programs, students may
obtain “bargain” interest rates such as 6% or 8% to attend college.
Frequently, payments are not due and interest does not accumulate
until you stop attending college. In Exercises 49 and 50, calculate
the amount of interest due 1 month after you must begin payments.
49. Borrowing for college. You have borrowed $10,000 at an an-
nual interest rate of 8%.
50. Borrowing for college. You have borrowed $15,000 at an an-
nual interest rate of 6%.
In Exercises 51–54, we will assume that the lender is using simple
interest to compute the interest on the loan.
51. Borrowing for a trip. You plan to take a trip to the Grand Canyon
in 2 years. You want to buy a certificate of deposit for $1,200 that
you will cash in for your trip. What annual interest rate must you
obtain on the certificate if you need $1,500 for your trip?
52. Paying interest on late taxes. Jonathan wants to defer pay-
ment of his $4,500 tax bill for 4 months. If he must pay an
annual interest rate of 15% for doing this, what will his total
payment be?
53. Borrowing from a pawn shop. Sanjay
has borrowed $400 on his father’s watch
from the Main Street Pawn Shop. He has
agreed to pay off the loan with $425 one
month later. What is the annual interest
rate that he is being charged?
54. Borrowing from a bail bondsman. If a
person accused of a crime does not have sufficient resources,
he may have a bail bondsman post bail to be released until a
Copyright © 2010 Pearson Education, Inc.
9.2 y Exercises 413
trial is held. Assume that a bondsman charges a $50 fee plus
8% of the amount of the bail. If a bondsman posts $20,000 for
a trial that takes place in 2 months, what is the interest rate
being charged by the bondsman? (Treat the $50 fee plus the
8% as interest on a $20,000 loan for two months.)
The computations for dealing with inflation are the same as for
determining future value. If an item sells for $100 today and there is
an annual inflation rate of 4% for 10 years, the item would then cost
100(1.04)10 = $148.02. The Bureau of Labor Statistics maintains an
index called the consumer price index (CPI), which is a measure of
inflation. The accompanying table shows the CPI for several recent
years. The CPI of 207.3 for 2007 means that the price of certain
basic items such as clothing, food, energy, automobiles, etc. that
would have cost $100 in 1982 to 1984, which are the base years for
the index, would now cost $207.30.
Year 2002 2003 2004 2005 2006 2007
CPI 179.9 184.0 188.9 195.3 201.6 207.3
Percent 2.3 2.7 3.4 3.2 2.8
Increase
In Exercises 55–58, you are given a year and the price of an item.
Use the percent increase in the CPI as the rate of inflation for the
next 10 years to calculate the price of that item 10 years later.
55. Inflation. 2004, fast-food meal, $4.65
56. Inflation. 2006, automobile, $17,650
57. Inflation. 2007, gallon of gasoline, $3.25
58. Inflation. 2005, athletic shoes, $96
59. Inflation. From 1992 to 1995, Albania experienced a yearly
inflation rate of 226%. Determine the price of the fast-food meal
in Exercise 55 after 5 years at a 226% inflation rate.
60. Inflation. The inflation rate in Hungary during the mid-1990s
was about 28%. Determine the price of the athletic shoes in
Exercise 58 after 10 years at a 28% inflation rate.
61. Comparing investments. Jocelyn purchased 100 shares of Jet
Blue stock for $23.75 per share. Eight months later she sold the
stock at $24.50 per share.
a. What annual rate, calculated using simple interest, did she
earn on this transaction?
b. What annual rate would she have to earn in a savings
account compounded monthly to earn the same money on
her investment?
62. Comparing investments. Dominick purchased a bond for
$2,400 to preserve a wildlife sanctuary and 10 months later he
sold it for $2,580.
a. What annual rate, calculated using simple interest, did he
earn on this transaction?
b. What annual rate would he have to earn in a savings
account compounded monthly to earn the same money on
his investment?
63. Investment earnings. Emily purchased a bond valued at
$20,000 for highway construction for $9,420. If the bond pays
7.5% annual interest compounded monthly, how long must she
hold it until it reaches its full face value?
414 CHAPTER 9 y Consumer Mathematics
64. Investment earnings. Lucas purchased a bond with a face
value of $10,000 for $4,200 to build a new sports stadium. If
the bond pays 6.5% annual interest compounded monthly,
how long must he hold it until it reaches its full face value?
Communicating Mathematics
65. What formula do we use to compute simple interest?
66. What is the difference between simple interest and compound
interest?
67. What is the meaning of each variable in the compound interest
n interest formula for finding future value to approximate what the
formula A = P A 1 + mr B ?
68. Explain the relationship between the formulas A = P(1 + r)t
n
and A = P A 1 + mr B .
69. Under what circumstances will A = P(1 + r)t and A =
n 74. nominal yield, 12%
P A 1 + mr B give you the same answers to a compound interest
problem?
70. Explain the difference in the techniques that you have to use to
solve a problem like Example 8 versus a problem like Example 9.
Using Technology to Investigate
Mathematics
71. Get a tutorial from your instructor that explains in more detail
how to use a calculator to solve finance problems. Use your
calculator to reproduce some of the examples in this section.
Your instructor also has Excel spreadsheets available for doing
financial computations; use them to reproduce some of the
computations in this section.*
Copyright © 2010 Pearson Education, Inc.
72. There are many good interactive financial calculators available
on the Internet. Find several and use them to verify some of the
computations that we did in this section.
For Extra Credit
Some banks advertise that money in their accounts is compounded
continuously. To get an understanding of what this means, apply the
compound interest formula using a very large number of compound-
ing periods per year. In Exercises 73 and 74, divide the year into
100,000 compounding periods per year. Apply the compound
effective annual yield would be if the compounding were done con-
tinuously for the stated nominal yield.
73. nominal yield, 10%
If the principal P is invested in an account that pays an annual
interest rate of r% and the compounding is done continuously, then
the future value, A, that will be in the account after t years is given
by the formula
A = Pert.
The number e is approximately 2.718281828.
75. Use the formula for continuous compounding to find the effec-
tive annual yield if the compounding in Exercise 73 is done
continuously.
76. Use the formula for continuous compounding to find the effec-
tive annual yield if the compounding in Exercise 74 is done
continuously.