LESSON 10: NOMINAL RATE VERSUS EFFECTIVE RATE OF INTEREST

Interest rates can be classified into nominal rate of interest or effective rate of interest.
Nominal rate of interest indicates the rate of interest and the number of interest periods per year.
This rate of interest is computed by using the following formula:
r
i=
m
where i= rate of interest per interest period
r= nominal interest rate
m= number of compounding periods per year
Example 1: What is the rate of interest per interest period if the nominal rate of interest is 12%
compounded monthly?
Solution:
r 12
i= = =1% (rate of interest per interest period)
m 12
Effective rate of interest (ERI) refers to the actual or exact rate of interest on the principal
during one year. The effective rate of interest is computed using the following formula:
m
r
[ ]
ERI= 1+
m
−1

Example 2:
What is the nominal interest rate which if converted monthly could be used instead of 12%
compounded annually? What are their corresponding effective rates?
Solution:
Let r= the unknown nominal rate.
For two nominal rates to be equivalent, their corresponding effective rates must be equal.
Nominal rate Effective Rate
12
r% compounded monthly r
[
1+
12 ]−1
1
12% compounded annually 0.12
[
1+
1 ]
−1

r 12 0.12 1
1+ (
12 ) ( )
−1= 1+
1
−1
12

(1+ 12r ) =1.12

r= 12( 12√ 1.12−1 )
=0.1139 or 11.39% compounded monthly

m 1
r 0.12
[ ] [
ERI= 1+
m
−1= 1+
1 ]
−1=1.12-1=0.12 or 12%

Alternative solution using the computed equivalent nominal rate:

12 12
r 0.1139
[
ERI= 1+ ]
12 [
−1= 1+
12 ] −1=1.120038261−1=0.12∨12%

DETERMINING INTEREST AS APPLIED TO MORTGAGE, AMORTIZATION,

SERVICES, UTILITIES, AND DEPOSITS AND LOANS
It is important that you know how interest is applied to mortgage, amortization, services,
utilities, deposits, and loans. This financial knowledge will help you in making wise decisions on
matters involving money.
Example 3:

BUSINESS MATHEMATICS 11 1
 You are making your biggest financial decision which is the purchase of your dream
house. You are planning to take out a mortgage. Your bank agreed to lend you a sum of money
to buy dream house and you agree to pay it back. The house serves as collateral for the loan
which means that if you fail to pay. the bank could repossess your house. How much is the total
interest paid over the mortgage term of 30 years if the mortgage of your dream house amounted
to P3 020 000 with annual percentage rate of 9.5%?
Solution
Find the equivalent nominal rate compounded monthly for the annual percentage rate
9.5%.
12 1
r 0.095
[ 1+
12 ] [ = 1+
1 ]
r=12 ( 12√ 1.095−1 ) =0.091098411
Mortgage Amount
Monthly Amortization = 1−(1+i)−n
i
P 3 020 000
0.0911 −(12∙ 30)
=
1− 1+
12 ( )
0.0911
12
= P24 539.01
Total Interest =(P24 539.01 × 360 ) – P3 020 000
= P8 834 043.60- P3 020 000
=P5 814 043.60
Example 4.
Mr. Reyes applied and was approved for a salary loan amounting to P24 000.
with a fixed rate of 5.5% per annum, how much will be the interest for 1 year?
How much will be his monthly amortization? Compute the principal and interest for the first
month on his salary loan.
Solution
Find the equivalent nominal rate compounded monthly for the 5.5% interest per annum.
12 1
r 0.055
[ 1+
12 ] [ = 1+
1 ]
r= 12( 12√ 1.055−1 )=0.053660387
LoanValue
Monthly Amortization = 1−(1+i)−n
i
24 000
0.0537 −( 1.12)
=
1−
12 ( )
0.0537
12
24,000
= 1−(1.0045)−12
0.0045
24,000
=
11.66
=P2 058.32

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Total Interest (Cost of credit) = (P2 058.32 ×12) – P24,000
= P699.84
Interest (1 month) = P24,000 × 0.0045 = P108
st

Principal Repaid (1st month) = P2 058.32 – P108 =P1 950.32

Example 5:
Services tax is an indirect tax paid by a service receiver to the government on or before
th
the 5 day of the month following the quarter for which service tax is payable with the
exemption for the quarter ending March to be paid on or before the 31st of march. The rate of
interest for delayed payment of service tax is 13%. Suppose you failed to pay your service tax of
P15,000 for the month of June, what is your interest liability if you remember to pay it only on
the 30th of July?
Solution:
Number of Days Delayed
Interest Payable = Unpaid Amount × ( 365 ) × 0.13

25
= P15,000 × × 0.13
365
= P133.56
Example 6:
Suppose you have a regular savings account with an available balance of P5,000. How much net
interest is earned by this deposit account for a month if the prevailing bank’s interest rate is 0.5%
per annum and the withholding tax is 20%?
Solution:
To compute the gross interest, use the simple interest formula I=Prt
1
Gross Interest = P5000 × 0.005 ×
12
Withholding Tax = Gross Interest × Withholding Tax Rate
= P2.08 × 0.20 = P0.42
Net interest = Gross Interest – Withholding tax
= P2.08 – P0.42 = P1.66
Alternative Solution
Net interest= Gross Interest × (1-With holding tax)
= P2.08 × 0.80= P1.66
Example 7:
An employee has placed her money amounting to P100,000 in a time deposit account for 90 days
with an interest rate o f 1.5% per annum. Considering 20% withholding tax, how much will be
her net interest income?
Solution:
90
Net Interest Income = P100 000 × 0.015 × × (1-0.20)
360
=P300
COMMISSION
Some companies pay their salespeople a straight salary, while others compensate their
salespeople through sales commission. Commission is the amount of money a salesperson
receives based on the level of his or her sales. This amount is based on an agreed percentage of
the revenue the salesperson based on the latter’s gross profit rather than on gross sales to make
sure that these companies maintain the profitability of their products or services. This is known
as the straight commission. Other companies combine salary with commission.
The amount of percentage salespeople receive may vary from product to product and may
depend on the level of their sales. Payment of commissions is commonly practices in real estate

BUSINESS MATHEMATICS 11 3
marketing. Commissions are paid to motivate salespeople to sell more because the bigger the
revenue through their sales, the bigger the commission would be.
Type of Commission
1. Straight commission is a compensation plan where the salesperson receives only a fixed
percent of sales. No fixed salary is given. There is no limit to the total commission that a
salesperson can earn.
Example 8:
Liza, a beauty product agent, was able to sell beauty products worth P48,000.
Given that her commission rate is 15%, how much will she receive if her earnings are
based on commission alone?
Solution:
Commission = Sales × Commission rate
= P48,000 × 0.15 = P7,200
2. Salary plus commission is an alternative compensation plan where a salesperson receives
a commission in addition to his or her fixed salary. This compensation plan offers
security of receiving something regardless of the level of sales a salesperson makes.
However. companies who offer this compensation plan usually have a high expectations
and quota that salesperson have to meet.

Example 9:
If Liza receives a monthly salary of P20,000 and 10% commission on her total
sales, what would be her total earnings for the same amount of sales (refer to example 9)
Solution:
Total Earnings = Monthly Salary + Sales Commission
= P20,000 + (P48,000 × 0.10¿
= P20,000+4800 = P24,800

3. Salary plus bonus is a compensation plan where salesperson receive a bonus if they
exceed their sales quota. This plan intends to keep salespeople motivated to do their best.
Example 10:

If Liza’s sales quota is P25 000, how much will be her earnings if she is given a
bonus of 12% if she exceeds her sales quota?

Solution:
Total Earnings = Monthly Salary + Bonus
= P20,000 + [ ( P 48,000−P 25,000 ) ×0.12 ]
= P20,000 + P2,760 = P22 760
4. Graduated commission is a compensation plan where the rate of commission increases as
the sales volume increases.
Examples 11:
If Liza receives no fixed salary and she is being paid based on a graduated
commission scheme, how much is her total earnings if she is paid 10% on the first
P20,000,15% on the second P20 000, and 20% on all sales in excess of P40,000?

Solutions:
Commission on the first P20,000 = P20,000 × 0.10 = P2,000
Commission on the second P20,000= P20,000 × 0.15= P3,000

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 Commission in excess of P40,000 = P8,000×0.20 = P1,600
P6,600
5. Override commission refers to the additional commission that sales managers or
supervisors earn from the sales of their sales representatives (subordinates)
Example 12:
If Liza’s sales supervisors receives 1% override commission from the sales of his
sales representatives, how much is the override commission of the sales supervisor based
on Liza’s sales alone?

Solution:
Override commission = P48,000 × 0.01 = P480

Solve the following problems.

1. How much commission will you earn if you sales amounted to P140 950 and you
receive a fixed commission rate of 6%?

2. How much commission will you earn if you made the same amount of sales (refer to
number 1), but you were given variable or graduated commission as follows:
Up to P50,000 3%
P50, 001 – P100,000 6%
P100 001 and above 10%

3. How much will be your total earning if you receive a fixed salary of P15,000 aside
from your commission of 12% on all your sales (refer to number 1)?

4. How much will be your total earnings if you received a fixed salary of P25,000 and a
bonus of 8% if you exceed your sales (for the total sales, refer to number 1)

BUSINESS MATHEMATICS 11 5
COMPUTING COMISSION ON CASH BASIS
Commission is computed on cash basis when a sales is computed. The commission is
based on cash received from the sale. Hence, it is a fee that a company pays to a salesperson in
exchange for his or her service in completing a sale.

Example 13:
Mercy works part-time as a real estate agent and earns a commission of 5% for the sales
she made. She was able to sell in cash three units of townhouses worth P1 409 640 (corner unit),
P1 115 960 (end unit). and P876,000 (inner unit). How much will be her total commission?
Solution:
Total sales = P1 409 640+P1,115 960+P876 000
= P3 401,600
Commission= Total Sales × Commission rate
= P3 401,600 × 0.05 = P170,080
Example 14:
For her birthday. Alyssa chose to have a brand new car instead of a debut party. Her
father bought her a brand new car worth P648,000 in cash. The car dealer gave them a discount
of P35,000. How much commission will the sales agent receives if he is given a commission rate
of 3%?
Solution:
Net selling price = Unit price – Discount
= P648,000 – P35,000 = P613,000
Commission = P613,000 × 0.03 = P18,390
COMPUTING COMMISSION ON INSTALLMENT BASIS
Commission is computed on installment basis when sales involve periodic payments
rather than cash payment. This computation of commission is commonly used by a company
when the method of selling involves installment transactions or credit terms. This is viewed as
effective in involving salespeople in collecting overdue accounts.

Example 15:
Kaye purchased a townhouse unit whose total contract price is P921 200. She paid
P5,000 as reservation fee which is to be deducted from the total contract price. She has to pay a
total gross equity of P106,200 in 18 months. Equity is the difference between the value of the
property and the cost of liabilities of owning the property. The balance will be paid through a
housing loan from a bank or Pag IBIG fund.
a. How much should Kaye pay monthly for the equity?
b. If the real estate agent receives 3% commission, how much will she receive as her
monthly commission on installment basis starting on the 7th equity payment based on the
company’s commission structure?
c. How much was the gross balance or the amount to be financed by the bank?
d. How much is the current increased balance (gross balance with added interest) when
charged with an interest rate of 32%?
e. What is the interest rate charged by Pag-IBIG fund if Kaye will pay monthly the amount
of P7,055.75 for 30 years?
f. Calculate the remaining balance interest (difference between the total amortization
payment and the gross balance).

BUSINESS MATHEMATICS 11 6
 Solution:
a. Monthly Equity = Total Equity ÷ 18 months
= P106 200÷ 18 = P 5 900
b. Total Commission = Total Contract Price × Commission rate
= P921 200 × 0.03 = P27,636
Commission on installment basis (12months) = P27 636 ÷ 12 = P2,303
c. Gross Balance (Amount to be Loaned) =Total Contract Price – (Reservation fee+
Total equity)
= P921,000 –(P5,000 +P106,200)
= P810,00
d. Current Increased Balance = Gross balance (1+Interest rate)
= P810,000 (1+0.32) = P 1,069 200
¿
e. Net Monthly amortization =amount ¿ be financed (1+ Interest rate) Loan term
P 810,000 ( 1+ Interest rate )
P 7 055.75 =
360
Interest Rate = [ ( P 7,055.75× 360 ) ÷ P 810,000 ]-1
= 2.1359 or or 213,59%
f. Remaining balance (net montly amortization × loan term - gross balance)
= (P7,055.75 ×360 )- P810,000
= P 2,540.070 - P810,000.
= P1 730 070
Example 23
Kyle, a sales agent, was able to sell a brand new car worth P648,000 this week. He
gave his buyer a discount of P35,000. His buyer paid a down payment that is 20% of
the net price. The balance will be paid through bank financing.
a. How much was the down payment?
b. How much was the gross balance or the amount to be financed by the bank?
c. How much is the current increased balance if the bank charges an interest rate of
30.75%?
d. How much total commission did Kyle receive if the car dealer pays a
commission rate of 3% based on the unit price and the bank gave him 1%
commission as sales incentive?
e. How much must the buyer pay monthly (amortization) for 6 years if the interest
rate specified by the bank is 30.75%
f. Calculate the remaining balance interest.
g. Determine the gross profit if the dealer price of the brand new car is P570,000/
h. What is Kyle’s gross commission?
i. Find the net profit of the car dealer if the withholding tax rate is 20%.
j. Compute Kyle’s net commission if the commission rate is 3%.
Solution:
a. Down payment = Net price × Down Payment rate
Net price = Unit price – Discount
= P648,000 - P35,000
= P613,000
Down payment = P613,000 × 0.20 = P122,600
b. Gross balance (amount to be financed through bank) = Unit price – Down
Payment
= P613,000 – P122,600

BUSINESS MATHEMATICS 11 7
 = P490,400
c. Current Increased balance = Gross Balance (1+ Interest rate)
= P490,400 (1+0.3075)=P641,198
d. Total Commission = Commission from the dealer+ Commission from the
bank
Commission from the Dealer = Net price × Commission Rate

= P613,000 × 0.03 = P18,390

Commission from the Bank = Amount to be financed × Commission Rate
= P490,400 × 0.01 = P 4,904
Total Commission = P18,390 + P4,904 = P23, 294
e. Net monthly Amortization =
amount ¿ be financed (1+ Interest rate) ¿
Loan term
P 490,400(1+0.3075)
=
72
=P8,905.53 ≈ P8,906.00
f. Remaining Balance Interest = Remaining Balance × Interest Rate
= P490,400 × 0.3075 =P 150 798
g. Gross profit = (Unit Price – Cost) + Remaining Balance Interest
= (P648 000 – P570 000) + P150 798
= P228 798
h. Gross Commission = Gross Profit × Commission rate
= P228,798 × 0.03 = P6 863.94
i. Net profit = Gross Profit (1 – withholding Tax rate )
= P228 798 (1-0.20) = P183 038.40
j. Net commission = Net profit × Commission Rate
= P183,038.40 × 0.03 = P5,491.15

Solve the following problems. (Please attached your complete

solution in a clean sheet of paper)
1. Josh is paid a straight commission of 5% on his total amount of sales. If his total sales for
the week amounted to P35,000, what is his commission?

2. Mark was able to sell a vehicle whose suggested retail price is P1 118 000. The vehicle
will be financed through a bank. The required down payment was P78 000 and the
monthly amortization for 6 years will be P22 494. The car dealer gave a 5% commission
rate.
a. What percent of the retail price is the down payment?
b. How much was the gross balance or the amount to be financed by the bank?
c. How much is the current increased balance if the bank charges an interest rate of
29.66%?
d. How much total commission did Mark earn if he received a commission of 5% based
on the gross balance from the car dealer and 1% sales incentive from the bank?

BUSINESS MATHEMATICS 11 8
 e. How much is the interest rate charged by the bank if the buyer will pay a monthly
amortization of P22 494 for 6 years?
f. Calculate the remaining balance interest.
g. Determine the gross profit if the dealer price of the brand new car is 80% of the unit
price.
h. What is Mark’s gross commission?
i. Find the net profit of the dealer if the withholding tax rate is 20%
j. Compute Mark’s net commission if his commission rate is 3%.

REFERENCE:
Agcaoli, Zenaida A., et Al. Business Operations: Mathematics of investments.
Philippines: Mutya Publishing House, 2001
Picar, J . Worktext in General Mathematics for Grade 11: A Comprehensive Approach:
Dioscesan Printing Press and Publishing Inc.

BUSINESS MATHEMATICS 11 9