When you deposit money in a bank, the bank usually pays you for the use of

your money. When you take out a loan from a bank, you have to pay the bank
for the use of their money. In both cases, the money paid is called the interest.

The Simple Interest Formula is given by

Simple Interest = Principal × Interest Rate × Time

I = Prt

where

The Principal (P) is the amount of money deposited or borrowed.

The Interest Rate (r) is a percent of the principal earned or paid.

The Time (t) is the length of time the money is deposited or borrowed.

Example:

Sarah deposits $4,000 at a bank at an interest rate of 4.5% per year. How much
interest will she earn at the end of 3 years?

Solution:

Simple Interest = 4,000 × 4.5% × 3 = 540

She earns $540 at the end of 3 years.

Example:

Wanda borrowed $3,000 from a bank at an interest rate of 12% per year for a
2-year period. How much interest does she have to pay the bank at the end of
2 years?
Solution :

Simple Interest = 3,000 × 12% × 2 = 720

She has to pay the bank $720 at the end of 2 years.

Example:

Raymond bought a car for $40, 000. He took a $20,000 loan from a bank at an
interest rate of 15% per year for a 3-year period. What is the total amount
(interest and loan) that he would have to pay the bank at the end of 3 years?

Solution :

Simple Interest = 20,000 × 13% × 3 = 7,800

At the end of 3 years, he would have to pay

$20,000 + $7,800 = $27,800

Tutorial on Simple Interest

Examples:
1. Ian is investing $4,000 for 2 years. The interest rate is 5.5%. How much
interest will Ian earn after 2 years?

2. Doug made a 3 year investment. The interest rate was 4.5%. After 3 years, he
earned $675 in interest. How much was his original investment?

3. Kim got a loan of $4700 to buy a used car. The interest rate is 7.5%. She paid
$1057.50 in interest. How many years did it take her to pay off her loan?
 Show Step-by-step Solutions
How to solve interest problems using the simple interest formula?
Interest represents a change in money.
If you have a savings account, the interest will increase your balance based
upon the interest rate paid by the bank.
If you have a loan, the interest will increase the amount you owe based upon
the interest rate charged by the bank.

Example:
1. If you invest $3,500 in savings account that pays 4% simple interest, how
much interest will you earn after 3 years? What ill the new balance be?

2. You borrow $6000 from a loan shark. If you will owe $7200 in 18 months,
what would be the simple interest rate?
 Show Step-by-step Solutions

How to use the formula for simple interest to find the principal, the rate or the
time?
Examples:
1. An investment earned $11.25 interest after 9 months. The rate was 5%. What
was the principal?

2. $2000 was invested for 3 years. It earned $204 in interest. What was the
rate?

3. A loan of $1200 had $36 in interest. The rate was 6%. What was the length of
the loan?
 Show Step-by-step Solutions
How to solve simple interest problems, compound interest problems,
continuously compounded interest problems, and determining the effective rate
of return?
Examples of Simple Interest problems
1. Joseph buys a new home using an interest only loan where he pays only the
interest on the value of the home each month. The home is valued at $200,000
and Joesph pays 5% interest per year on the home. How much is his monthly
interest payment?
2. Anthony puts $10000 dollars into a savings account that pays interest every
month at a rate of 1.8% per year. How much money does Anthony have after
one month? If he leaves his original investment and the first month of interest
in the account, how much will he have after the second month?

Examples of Compound Interest problems

1. Matt is saving for a new car. He invests $5000 into an account that pays 3%
interest a year and is compound monthly. How much will he have after 5 years?

2. Matt is planning to buy a car in three years. He wants to invest $5000 now
and hopes to have $6000 to spend on the car when he buys it. What kind of
interest rate would he need if his investment is compounded monthly?

Examples of Continuously Compounded Interest Problems

1. Lindsey invests $1000 into an account with 4% per year continuously
compounded interest. How much will she have after 10 years? How long will it
take for her investment to double?

2. Tony and Matt both incest $5000 in an account that receives 3% interest
annually for 10 years. Tony invests in an account that is compounded monthly.
Matt invests in an account that is compounded continuously. Who made the
better investment.

Examples of Effective Rate of Return

1. If $2500 is invested at 5% compounded monthly, what is the effective rate of
return. What is the effective rate of return if this investment is compounded
semiannually?
1. A principal of $2000 is placed in a savings account at 3% per annum
compounded annually. How much is in the account after one year, two
years and three years?
2. What would $1000 become in a saving account at 3% per year for 3
years when the interest is not compounded (simple interest)? What
would the same amount become after 3 years with the same rate but
compounded annually?
3. $100 is the principal deposited in a 5% saving account not compounded
(simple interest). The same amount of $100 is placed in a 5% saving
account compounded annually. Find the total amount A after t years in
each saving plan and graph both of them in the same system of
rectangular axes. Use the graphs to approximate the time it takes each
saving plan to double the initial amount.
4. If $3000 is placed in an account at 5% and is compounded quarterly for
5 years. How much is in the account at the end of 5 years?
5. $1200 is placed in an account at 4% compounded annually for 2 years.
It is then withdrawn at the end of the two years and placed in another
bank at the rate of 5% compounded annually for 4 years. What is the
balance in the second account after the 4 years.
6. $1,200 is placed in an account at 4% compounded daily for 2 years. It is
then withdrawn and placed in another bank at the rate of 5%
compounded daily for 4 years. What is the balance in the second
account after the 4 years. (compare with the previous problem)
7. $1200 is placed in an account at 4% compounded continuously for 2
years. It is then withdrawn and placed in another bank at the rate of 5%
compounded continuously for 4 years. What is the balance in the
second account after the 4 years. (compare with the two previous
problem)
8. What principal you have to deposit in a 4.5% saving account
compounded monthly in order to have a total of $10,000 after 8 years?
9. A principal of $120 is deposited in a 7% account and compounded
continuously. At the same time a principal of $150 is deposited in a 5%
account and compounded annually. How long does it take for the
amounts in the two accounts to be equal?
10. A first saving account pays 5% compounded annually. A second
saving account pays 5% compounded continuously. Which of the two
investments is better in the long term?

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11. What interest rate, compounded annually, is needed for a

principal of $4,000 to increase to $4,500 in 10 year?
12. A person deposited $1,000 in a 2% account compounded
continuously. In a second account, he deposited $500 in a 8% account
compounded continuously. When will the total amounts in both accounts
be equal? When will the total amount in the second accounts be 50%
more than the total amount in the second account?
13. A bank saving account offers 4% compounded on a quarterly
basis. A customer deposit $200, in this type of account, at the start of
each quarter starting with the first deposit on the first of January and the
fourth deposit on the first of October. What is the total amount in his
account at the end of the year?
14. An amount of $1,500 is invested for 5 years at the rates of 2% for
the first two years, 5% for the third year and 6% for the fourth and fifth
years all compounded continuously. What is the total amount at the end
of the 5 years?

Solutions to the Above Questions

1. Solution
When interest is compounded annually, total amount A after t years is
given by: A = P(1 + r) t, where P is the initial amount (principal), r is the
rate and t is time in years.
1 year: A = 2000(1 + 0.03) 1 = $2060
2 years: A = 2000(1 + 0.03) 2 = $2121.80
3 years: A = 2000(1 + 0.03) 3 = $2185.45
2. Solution
Not compounded: A = P + P(1 + r t) = 1000 + 1000(1 + 0.03 · 3) =
$1090
Compounded: A = P(1 + r) t = 1000(1 + 0.03) 3 = $1092.73
Higher return when compounded.

3. Solution
Not compounded: A = P + P(1 + r t) = 100(1 + 0.05 t)
Compounded: A = P(1 + r) t = 100(1 + 0.05) t
Graphs below are those of the compounded and not compounded
interests. The compounded interest doubles in about 14 years while the
non compounded (simple) interest doubles in about 20 about years.

4. Solution
Compounded n times a year and after t years, the total amount is given
by: A = P(1 + r/n)n t
quarterly n = 4: Hence A = P(1 + r/4) 4 t = 3000(1 + 0.05/4) 4 × 5 =
$3846.11

5. Solution
Annual compounding
 First two years: A = P(1 + r) t = 1200(1 + 0.04) 2 = $1297.92
Last four years : A = P(1 + r) t = 1297.92(1 + 0.05) 4 = $1577.63

6. Solution
Daily compounding (assuming 365 days per year)
First two years: A = P(1 + r / 365)

= 1200(1 + 0.04 / 365) 365 × 2 = $1299.94

365 t

Last four years : A = P(1 + r / 365) 365 t = 1299.94 (1 + 0.05 / 365) 365 ×4 =
$1587.73
Higher final balances compared to annual compounding in last problem.

7. Solution
In continuous compounding, final balance after t years is given by: A = P
e r t.
First two years: A = P e r t = 1200 e 0.04 × 2 = $1299.94
Last four years : A = P e r t = $1299.94 e 0.05 × 4 = $1587.75
Same balances compared to daily compounding in last problem.

8. Solution
P initial balance to find and final balance A known and equal to
$10,000.
A = P(1 + 0.045 / 12) 12 × 8 = 10,000
P = 10,000 / ( (1 + 0.045 / 12) 12 × 8 ) = $6981.46

9. Solution
Continuous compounding: A 1 = 120 e 0.07 t
Annual compounding: A 2 = 150 (1 + 0.05)t
A1 = A2
120 e 0.07 t = 150 (1 + 0.05)t
Take log base e (ln) of both sides.
ln(120 e 0.07 t) = ln( 150 (1 + 0.05)t )
Use property ln(A B) = ln(A) + ln(B) to rewrite the above as:
ln(120) + ln(e 0.07 t) = ln(150) + ln ( (1 + 0.05)t )
 Use properties ln A n = n ln(A), ln(e n) = n to simplify.
ln(120) + 0.07 t = ln(150) + t ln( 1+ 0.05)
Solve for t.
t (0.07 - ln( 1 + 0.05) ) = ln(150) - ln(120)
t = [ ln(150) - ln(120) ] / [ 0.07 - ln( 1 + 0.05) ] ≅ 10.5 years
Check graphically below. Graphs intersect when A 1 = A 2.

10. Solution
Continuous compounding: A 1 = 100 e 0.05 t
Annual compounding: A 2 = 100 (1 + 0.05)t
From graphs below, at equal rates, the continuous compounding earns
more that the annual compounding in the long term.
11. Solution
P initial balance is equal to $4,000 and final balance is equal to $4,500.
A = P(1 + r) t = 4,500
4000(1 + r) 10 = 4,500
(1 + r) 10 = 4500 / 4000
Take ln of both sides.
10 ln(1 + r) = ln(4500 / 4000)
ln(1 + r) = ln(4500 / 4000) / 10
1 + r = e 0.1 ln(4500 / 4000)
r = e 0.1 ln(4500 / 4000) - 1 ≅ 0.012

12. Solution
A 1 = 1000 e 0.02 t
A 2 = 500 e 0.08 t
A 1 = A 2 gives
1000 e 0.02 t = 500 e 0.08 t
Divide both sides by 500 e 0.02 t and simplify
100 / 500 = e 0.08 t - 0.02 t
2 = e 0.06 t
Take ln of both sides.
0.06 t = ln 2
t = ln 2 / 0.06 ≅ 11.5 years
A 2 is 50% more than A 1 gives the equation:
A 2 = 1.5 A 1
500 e 0.08 t = 1.5 × 1000 e 0.02 t
e 0.08 t - 0.02 t = 3
0.06 t = ln 3
t ≅ 18.5 years

13. Solution
A = P(1 + r/n) n t
First quarter deposit, t = 1 year: A 1 = 200 (1 + 0.04 / 4) e 4 × 1 = $208.12
Second quarter deposit, t = 3/4 of 1 year : A 2 = 200 (1 + 0.04 / 4) e 4 ×
3/4 = $206.06

Third quarter deposit , t = 1/2 of 1 year : A 3 = 200 (1 + 0.04 / 4) e 4 × 1/2 =

$204.02
 Fourth quarter deposit, t = 1/4 of 1 year : A 4 = 200 (1 + 0.04 / 4)e 4 × 1/4 =
$202
Total amount = $208.12 + $206.06 + $204.02 + $202 = $820.2

14. Solution
A = P e rt
End of first two years: A 1 = 1500 e 0.02 × 2
End of third year: A 2 = A 1 e 0.05 × 1
End of fifth year (last two years): A 3 = A 2 e 0.06 × 2 = 1500 e 0.02 × 2 + 0.05 × 1 + 0.06
× 2 = $1850.51

Example 1

Determine the correct data type (quantitative or qualitative). Indicate whether

quantitative data are continuous or discrete. Hint: Data that are discrete often start with
the words “the number of.”

1. The number of pairs of shoes you own

2. The type of car you drive
3. The place where you go on vacation
4. The distance it is from your home to the nearest grocery store
5. The number of classes you take per school year.
6. The tuition for your classes
7. The type of calculator you use
8. Movie ratings
9. Political party preferences
10. Weights of sumo wrestlers
11. Amount of money (in dollars) won playing poker
12. Number of correct answers on a quiz
13. Peoples’ attitudes toward the government
14. IQ scores
Show Answer
Items a, e, f, k, and l are quantitative discrete; items d, j, and n are quantitative
continuous; items b, c, g, h, i, and m are qualitative.