EECO101

ENGINEERING ECONOMY
Compound
Interest
Objectives:
Solve problems involving compound interest

Compute nominal and effective rate

Compare different varieties of compound interest

Compound Interest
– the interest resulting from the periodic
addition of simple interest to the principal
Compound Amount
– the resulting value when the interest is
periodically added to the principal and this new
sum is used as the new principal for a certain
number of periods
Compounding or Conversion Period
– the time between the successive interest
computations
Notations:
m – the number of conversion periods for one year
n – the total number of conversion periods for the
whole investment term
conversion periods:
Annually m=1
Semi-annually m=2
Quarterly m=4
Monthly m = 12
Total number of conversion periods for the whole
term:
n = time x number of conversion periods m
n= txm
• TERM: 𝟓 𝒚𝒆𝒂𝒓𝒔

• Compounded annually: 𝟓×𝟏 𝒏=𝟓

• Compounded semi - annually: 𝟓×𝟐 𝒏 = 𝟏𝟎

• Compounded quarterly: 𝟓×𝟒 𝒏 = 𝟐𝟎

• Compounded monthly: 𝟓 × 𝟏𝟐 𝒏 = 𝟔𝟎
Interest rate (r) – usually expressed as an annual or
yearly rate, and must be changed to the interest rate
per conversion period (periodic rate: i) and can be
found from the relation:

𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 (𝑟)

𝑖=
𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟 (𝑚)
𝑟
𝑖=
𝑚
Formula
𝑛
𝐹 = 𝑃(1 + 𝑖)
𝐼 =𝐹−𝑃
F – final or compound amount
P – original principal
𝒓
i – periodic rate 𝒊 =
𝒎
n – total number of conversion periods for the whole term 𝒏 = 𝒕𝒎
I – compound interest
n P I F
1 P Pi P + Pi = P(1+i)
2 P(1+i) P(1+i)i P(1+i) + P(1+1)i = P(1+i)2
3 P(1+i)2 P(1+i)2i P(1+i)2 + P(1+i)2i = P(1+i)3

n P(1+i)n-1 P(1+i)n-1 i P(1+i)n