Generally, there are two types of interest used:

a. Simple Interest
b. Compound Interest
Let us discuss first Simple Interest

Simple Interest
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. Interest is simply the price paid for the use of borrowed money. It is usually
expressed as a percent. Here we shall look at a formula for simple interest.

Simple Interest, by definition, is interest calculated on the principal portion or original amount of a loan or
the original amount contributed to a savings account.

Simple interest does not compound, meaning that an account holder will only gain interest on the principal,
and a borrower will never have to pay interest on interest already accrued.

Simple interest is basically having 2 kinds:

 Ordinary simple interest is a simple interest that uses 360 days as the equivalent number of days in a
year.
 Exact simple interest is a simple interest that uses exact number of days in a year which is 365 (or 366
for leap year).

 Simple Interest Formula

The Simple Interest Formula is given by:

Simple Interest = Principal × Interest Rate × Time

I = Prt

Where:
I is the amount of interest earned after a given period of time
P is the principal or original amount of money deposited or borrowed.
r is the Interest Rate or percentage of the principal earned or paid expressed as a decimal.
t is the length of time the money is deposited or borrowed expressed in years.

Here is an illustrative diagram of the Simple Interest formula to easily determine all of the formulas.
The total amount of money earned from P deposited at r per year after t years is given by the formula:

P (t) = simple interest earned + Principal amount

P (t) = I + P
Where:
 P = principal amount at present
I = Interest
= Prt
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.

Compound Interest
Compound interest or 'interest on interest' is the addition of interest to the principal sum of a loan or
deposit, or in other words, interest on interest.

Here's an explanation that should make everything crystal clear:

When you take out a loan, interest is calculated for the first period (be it a month or a year). This interest is
then added to the original total. Following on from that, the interest for the next period is calculated but is based
on the gross figure from the first period. From there, well, you get the idea.

The formula for compound interest, including principal sum, is:

Future Amount = Principal x (1 + rate per period)Number of periods or

Where:

A = the future value of the investment/loan, including interest

P = the principal investment amount (the initial deposit or loan amount)
r = the annual interest rate (decimal)
n = the number of times that interest is compounded per unit t or periods per year
t = the time or number of years the money is invested or borrowed for

Note: The nominal rate of interest is the annual interest rate.

Number of Periods = Periods per Year x Number of Years

Take Note:
For the value of n, it comes in many durations such as:
Annually =1
Semi-annually = 2
Quarterly =4
Monthly = 12
Daily = 365
Weekly = 52

To solve for t, use the formula:

and

Note: When approximating or rounding off the number of years or periods into a whole number, consider
the nearest larger whole number.

Similar to simple interest, the same common factors affect compound interest but there are some additional
things that should be taken into account.

Principal: This is the amount which is being invested or borrowed. This amount increases periodically as
interest accumulated in each period is added to the principal as the new principal amount.
Compounding: Unlike simple interest, the rate of interest (nominal) should be divided by the number of
periods that the interest would be compounded in a year.

For example:

Rate of Interest: This is the percent rate to be used to calculate the additional amount to be earned or paid for
using the money. The rate of interest to be used for each period depends on the manner that the interest is
being compounded.

Number of Periods
The period in compound interest is not the entire duration of the transaction but it is the time interval in
which the compound interest will be applied. The formula for getting the number of periods is:

Number of Periods = Periods per Year x Number of Years

For example:

10% compounded monthly for 2 years. Compound interest is applied every month. Therefore, the number
of periods would be 12 months/year x 2 years = 24.

It's worth noting that this formula gives you the future value of an investment or loan, which is compound
interest plus the principal. Should you wish to calculate the compound interest only, you need to deduct the
principal from the result. So, your formula looks like this:

Compounded interest only (without principal):

P (1 + r/n) (nt) - P
 The benefits of compound interest

Compound interest is a more effective way of earning than simple interest, which only works on your initial
deposit.

For example, if you had Php 25,000 in a savings account earning 4% simple interest p.a., you’d have Php
30,000 in 5 years.

If you had the same Php 25,000 in a savings account earning 4% p.a. compounding monthly, you’d have Php
30,525. That’s Php 500 more in your pocket, and you didn’t have to lift a finger.

 The flip side

While compound interest is great for your savings account, it’s not so good for loan repayments. For home,
personal or car loans, your interest is built into the monthly repayments, so you don’t have to think about it.
 With credit card debt it becomes a little trickier. If you’re only making the minimum payments on your
credit card balance, you’re not really getting anywhere as far as paying off the principal goes, and interest can
compound quickly.

Let's look at an example:

If an amount of Php 5,000 is deposited into a savings account at an annual interest rate of 5%, compounded
monthly, the value of the investment after 10 years can be calculated as follows.

P = 5000.
r = 5/100 = 0.05 (decimal)
n = 12.
t = 10.

If we plug those figures into the formula, we get the following:

(12 * 10)
A = 5000 [1 + (0.05 / 12)] = 8235.05.
So, the investment balance after 10 years is Php 8,235.05

Sample Problems:

1. A youth group has a yard sale to raise money for a charity. The group earns Php800.00 but decides
to put its money in the bank for a while. Calculate the amount of money the group will have if:

a. Cool Bank pays simple interest at a rate of 4%, and the youth group leaves the money in for 3 years.

b. Hot Bank pays an interest rate of 3% compounded annually, and the youth group leaves the money in
for 5 years.

c. If the youth group needs the money quickly, which is the better choice? Why?
Solution:

A. Solve for P (3) at simple interest

Where:
P = 800
r = 4%
t=3

P (t) = Prt + P
P (3) = 800(0.04) (3) + 800
= 896.00

B. Solve for A compounded annually

Where:
P = 800
r = 3% = 0.03 r/n = 0.03/1 = 0.03
t = 5 years nt = 1(5) = 5

nt
A = P (1+ r/n )
= 800 (1+ 0.03)5
= Php 927.42

C. Which between the two interests should the group choose If the youth group needs the money quickly?
 Answer:
The simple interest rate will grow quicker at first. So, they should go with Cool Bank.

2. Wanda borrowed Php 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:
I = Prt

Simple Interest = 3,000 × 12% × 2 = Php 720.00

She has to pay the bank Php 720.00 at the end of 2 years.

3. You borrow Php 6,000.00 from a loan shark. If you will owe Php 7,200.00 in 18 months, what would
be the simple interest rate?

Solution:

6000 = P
7200 = P(t) = P [(18) x (1/12)] = P (1.5)

7200 – 6000 = 1200 = I

I = Prt
1200 = 6000 (r) (1.5)
1200 = 9000 r
0.1333 = r
r = 13.33%

4. The company loaned Php 60,000 to be used for constructing the new comfort rooms. The bank
charges 3% interest compounded monthly. If the company paid a total of Php 69,697.01 how long
did, they pay the loan?

Solution:

P = 60,000.00 A = 69,697.01
r = 3% compounded monthly r/n = 3%/12 = 0.0025
t =?

Number of periods = log(69,697.01/60,000) / log(1+ 0.0025)

Number of periods = log1.162 / log1.0025
Number of periods = 0.065/0.00108
Number of periods = 59.94 = 60

determining the number of years:

Number of years = Number of periods / Periods per year
Number of years = 60/12
Number of years = 5 years

5. What principal you have to deposit in a 4.5% saving account compounded monthly in order to
have a total of Php 10,000 after 8 years?

Solution:
 A = 10,000
r = 4.5% compounded monthly; r/n = 0.045/12 = 0.00375
t=8 nt = 12(8) = 96
nt
A = P (1 + r/n )
96
10,000.00 = P (1 + 0.00375)
96
10,000.00 = P (1.00375)
10,000.00 = P (1.432364654)
P = 10,000.00/1.432364654
P = Php 6,981.46

Distinguishing Compound Interest from Simple Interest

Simple interest and compound interest differs in many aspects. Here are some of their differences:

 Compound interest is earned periodically. Simple interest is earned only once within the agreed period
of payment.
 Compound interest increases exponentially period after period. Simple interest grows in a consistent
manner.
 Rate of simple interest is annual. Compound interest rates can be yearly, monthly, quarterly, weekly etc.
 Total amount earned or paid using simple interest is less as compared to the total amount earned or paid
using compound interest.
 Simple interest is usually used for short term transactions since it earns less. Compound interest is
preferable for long term transactions to increase wealth.
 Calculation for future amount in compound interest is complex than with simple interest since it
involves division and exponents.

TIME VALUE OF MONEY

Time Value of money
 means that the value of money is different in different time periods.
 it is the difference in the value of money today and tomorrow.
 The value of money received today is more than the value of same amount receivable at some other
time in future.

Techniques of Time Value of Money

Two most common methods of adjusting cash flows for time value of money:
1. Compounding – the process of calculating future values of cash flows
2. Discounting - the process of calculating present values of cash flows

The fact that Php100 today grows to Php105 in one year at 5% annual interest is an example of the time
value of money principle.

This principle states that funds placed in a secure investment will increase in value in a way
that depends on the elapsed time and the interest rate.

The interest rate that is used in calculations is known as the effective interest rate. If compounding is once
a year it is known as the effective annual interest rate. However, effective quarterly, monthly, or daily
interest rates are also used.

The Concept of Equivalence

 Economic equivalence is a fundamental concept upon which engineering economy computations are
based. Before we delve into the economic aspects, think of the many types of equivalencies we may utilize
daily by transferring from one scale to another. Some example transfers between scales are as follows:

Now we consider economic equivalency.

Economic equivalence is a combination of interest rate and time value of money to determine the
different amounts of money at different points in time that are equal in economic value.

As an illustration, if the interest rate is 6% per year, Php 100.00 today (present time) is equivalent to
Php 106.00 one year from today.

Amount accumulated = 100 + 100(0.06) = 100(1 + 0.06) = Php 106.00

Example:

Manufacturers make backup batteries for computer systems available to Batteries + dealers through
privately owned distributorships. In general, batteries are stored throughout the year, and a 5% cost
increase is added each year to cover the inventory carrying charge for the distributorship owner.
Assume you own the City Center Batteries + outlet. Make the calculations necessary to show which
of the following statements are true and which are false about battery costs.

The amount of Php98 now is equivalent to a cost of Php105.60 one year from now.
(b) A truck battery cost of Php200 one year ago is equivalent to Php205 now.
(c) A Php38 cost now is equivalent to Php39.90 one year from now.
(d) A Php3000 cost now is equivalent to Php2887.14 one year earlier.
(e) The carrying charge accumulated in 1 year on an investment of Php20,000 worth of batteries is
Php1000.

CASH FLOW
Cash flow
is the sum of money recorded as receipts or disbursements in a project’s financial records.
 The following table shows the cash flow for a simple 6-month project. The project starts on January 1 with
a small initial investment and receives income in two installments.

While a cash flow diagram shows a visual representation of a cash flow (receipts and disbursements)
wherein it presents the flow of cash as arrows on a time line scaled to the magnitude of the cash flow, where
expenses are down arrows and receipts are up arrows.

For instance, here is the cash flow diagram for the cash flow described in the table above.

Cash-Flow Diagram—Details

 The horizontal axis represents time. It is divided into equal time periods (days, months, years, etc.)
and stretches for the duration of the project.
 Cash inflows (income, withdraws, etc.) are represented by upward pointing arrows.
 Cash outflows (expenses, deposits, etc.) are represented by downward pointing arrows.
 Cash flows that occur within a time period (both inflows and outflows), are added together and
represented with a single arrow at the end of the period.
 When space allows, arrow lengths are drawn proportional to the magnitude of the cash flow.
 Initial investments are show at time 0.
 Dashed arrow line indicates amount to be determined.

Cash Flow example:

A lawn mower will cost $600. Maintenance costs are expected to be $180 per year. Income from mowing
lawns is expected to be $720 a year. The salvage value after 3 years is expected to be $175.

The cash flow diagram of the above sample can be represented either of the two below:
 The first diagram shows the detailed amounts incurred indicating amounts with + as cash inflow while
amounts with – as cash outflow or disbursement.

The second diagram shows a simplified cash flow diagram wherein cash inflow & outflow per year are
added automatically to show the amount of balance acquired per year until the end of the period.

If Cash inflow is even ( Annuity)

ANNUITY
- is a series of even cash flows for a specified duration.
- It involves a regular cash outflow or inflow
- examples are recurring deposit, systematic investment plan, life insurance premium etc.
Annuity Due
- cash flows happen at the beginning of the year
Regular or ordinary or deferred Annuity
- cash flows happen at the end of the year

Lesson Summary

Simple Interest:
 Interest is calculated once per year on the original amount borrowed or invested. The interest does not
become part of the amount borrowed or owed (the principal).

Compound Interest:
  Interest is calculated once per period on the current amount borrowed or invested. Each period, the
interest becomes a part of the principal.
 The compound interest formula is used when an investment earns interest on the principal and the
previously-earned interest. Investments like this grow quickly; how quickly depends on the rate and the
number of compounding periods. When working with a compound interest formula question, always
make note of what values are known and what values need to be found so that you stay organized with
your work.

Assessment:
Simple Interest
1. Juan is investing Php 4,000.00 for 2 years. The interest rate is 5.5%. How much interest will Ian earn
after 2 years? 10pts
2. Pedro made a 3-year investment. The interest rate was 4.5%. After 3 years, he earned Php 675.00 in
interest. How much was his original investment? 10pts
3. Kim got a loan of Php 4,700.00 to buy a used car. The interest rate is 7.5%. She paid Php 1057.50 in
interest. How many years did it take her to pay off her loan? 10pts.

Solution:
1. I = ?
P= 4,000
r= 0.055
t= 2

I= Prt
= (4000) (0.055) (2)
= 440.00

2. t = 3
r = 0.045
I = 675
P =?
Solution:

P= I/rt
= 675/ (0.045 x 3)
= 675/ 0.135
= 5000

3. I = 1057.50
 P = 4700
r = 0.075
t =?
Solution:

t = I / Pr
= 1057.50 / {(4700) (0.075)}
= 1057.50 / 352.50
= 3 years

Compound Interest

1. An amount of Php 2,000 is invested at a rate of 2% compounded yearly. How much will be the amount
after 2 years?

2. A company paid a total of Php 15M for the loan of the 5-hectare lot that was paid for 10 years at 6%
compounded monthly. How much was the price of the lot?

Solution:

1. A = ?
P = 2,000.
r = 2% compounded yearly.
t =2

Determining the rate of interest per period: r/n = 2%/1 = 2%

Note: There is 1 period for every year because it is yearly.

Determining the number of periods;

Number of Periods = Periods per Year x Number of Years
Number of Periods = 1 x 2
Number of Periods = 2

Using the formula for solving the future amount:

nt
A = P (1 + r/n )
2
A = 2000 (1+ 0.02)
2
A = 2000 (1.02)
A = 2,080.80

2. P = ?
A = 15,000,000.00
r = 6% compounded monthly r/n = 6%/12 = 0.005
t = 10 nt = 12(10) = 120

A = P ( 1+ r/n ) nt
15,000,000.00 = P (1+0.005) 120
15,000,000.00 = P (1.819396734)
P = 15,000,000.00/1.819396734
P = Php 8, 244, 491.00
Reference:
https://www.thecalculatorsite.com/articles/finance/compound-interest-formula.php

Suggested Videos to watch:

1. Compound Interest Formula Explained, Investment, Monthly & Continuously, Word Problems, Algebra
https://www.youtube.com/watch?v=P182Abv3fOk

2. Compound Interest (Problem Solving) – Number Sense 101

https://www.youtube.com/watch?v=sMKCZQESF84