Simple and Compound Interest

Objectives
1. Define simple and compound interest.
2. Differentiate simple from compound interest.
3. Compute interest, maturity value and to be able
to identify partial payments in simple interest
environment.
4. Solve problems involving simple interest
5. Apply the concept of simple and compound
interest in their daily life by solving word
problems.
Table of Contents

01 Tasks 02 Discussion
 “Compound interest is the
eighth wonder of the world.."
~ Albert Einstein
The key requirement for generating compound interest is time –
the longer you leave your money to grow, the more pronounced
and positive the outcome.
 01
Task 1
Question:
Give your own answers to the question,

“What are some ways to take

care of hard-earned
money?”
Definition of Terms
 Lender or creditor - person (or institution) who invests the
money or makes the funds available
 Borrower or debtor - person (or institution) who owes the money
or avails of the funds from the lender
 Origin or loan date - date on which money is received by the
borrower
 Repayment date or maturity date- a date on which the money
borrowed or loan is to be completely repaid
 Time or term (t) - amount of time in years the money is
borrowed or invested; length of time between the origin and
maturity dates
Definition of Terms
• Principal (P) - amount of money borrowed or invested on the origin
date
• Rate (r) - annual rate, usually in percent, charged by the lender, or rate
of increase of the investment
• Interest (I) - amount paid or earned for the use of money
• Simple Interest (Is) - interest that is computed on the principal and
then added to it
• Compound Interest (Ic) - interest is computed on the principal and also
on the accumulated past interests
• Maturity value or future value (F) - amount after t years; that the
lender receives from the borrower on the maturity date
Example

Suppose you won P10, 000 and you plan to

invest it for 5 years. A cooperative group
offers 2% simple interest rate per year. A
bank offers 2% compounded annually.
Which will you choose and why?
Solution. Investment 1: Simple interest, with annual rate r

Principal Simple Interest Amount after t years

Time (t)
(P) Solution Answer Maturity Value
1 (10, 000) (0.02) (1) 200 10, 000 + 200 = 10, 200.00
2 (10, 000) (0.02) (2) 400 10, 000 + 400 = 10, 400.00
3 (10, 000) (0.02) (3) 600 10, 000 + 600 = 10, 600.00
10, 000
4 (10, 000) (0.02) (4) 800 10, 000 + 800 = 10, 800.00

5 (10, 000) (0.02) (5) 1, 000 10, 000 + 1, 000 = 11, 000.00
Investment 2: Compound interest, with annual rate r
Compund Interest
Principal Solution Answer Amount after t years
Time (t)
(P) Maturity Value

1 10, 000 (10, 000) (0.02) (1) 200 10, 000 + 200 = 10, 200.00
2 10, 200 (10, 200) (0.02) (1) 204 10, 200 + 204 = 10, 404.00
3 10, 404 (10, 404) (0.02) (1) 208.08 10, 404 + 208. 08 = 10, 612.08

4 10, 612. 08 (10, 612.08) (0.02) (1) 212.24 10, 612. 08 + 212.24 = 10, 824.32

5 10, 824. 32 (10, 824. 32) (0.02) (1) 216. 49 10,824.32 + 216.49 =11,040.81
 01
Task 2
 Question:

Compare the interests gained in the two investments.

 Simple Interest (in pesos): 11,000 - 10,000 = 1,000

 Compound Interest (in pesos): 11,040.81 - 10,000 = 1,040.81
 02
Discussion
Simple Interest
An annual simple interest is based on the 3 factors:

a. Principal which is the amount invested or borrowed

b. Simple interest rate, usually expressed in percent
c. Time or term of loan, in years
Annual Simple Interest

Is = Prt
where;
Is = simple interest
P = principal
r = rate
t = term or time, in years
Example 1

A bank offers 0.25% annual simple interest

rate for a particular deposit. How much
interest will be earned if 1 million pesos is
deposited in this savings account for 1
year?
Solution

Given: P = 1, 000, 000 r = 0.25% = 0.0025 t = 1 year

Find: Is
Is = Prt = (1, 000, 000) (0.0025) (1) = 2, 500

So, the interest earned is P2, 500.

Example 2

How much interest is charged when

P50, 000 is borrowed for 9 months at
an annual simple interest rate of
10%?
Solution
9
Given: P = 50, 000 r = 10% = 0.10 t= year = 0.75 year
12

Find: Is Note: When the term is expressed in months (M), it should be converted to years by =
𝑴
𝟏𝟐
.

9
Is = Prt = (50, 000) (0.10) = (50, 000) (0.10) (0.75) = 3, 750
12

The simple interest charged is P3, 750.

Example 3

When invested at an annual interest rate

of 7%, an amount earned P11, 200 of
simple interest in two years. How much
money was originally invested?
Solution

Given: r = 7% = 0.07 t = 2 years ls = 11, 200

Find P;
𝑰𝒔 11,200
𝑷= = = 80, 000
𝒓𝒕 0.07 (2)

The amount invested is P80, 000.

Example 4

If an entrepreneur applies for a loan

amounting to P500, 000 in a bank, the
simple interest of which is P157, 500 for 3
years, what interest rate is being charged?
Solution

Given: P = 500, 000 Is = 157, 500 t = 3 years

Find r;

𝑰𝒔 157,500
𝒓= = = 0.105 𝑜𝑟 10.5%
𝑷𝒕 500,000 (3)

The bank charged an annual simple interest rate of 10.5%.

Example 5

How long will a principal earn an

interest equal to half of it at 5%
simple interest?
Solution

1
Given: P r = 5% = 0.05 Is = 𝑃 = 0.5P
2

Find t;
𝑰𝒔 0.5𝑃
𝒕= = = 10 𝑦𝑒𝑎𝑟𝑠
𝑷𝒓 𝑃(0.05)

It will take 10 years for a principal to earn half of its value at 5%

simple annual interest rate.
Maturity
Value
Maturity (Future)Value

When a certain amount of money is deposited or

borrowed, the sum of money at the end of the
period is called maturity or accumulated value.
The maturity or accumulated value is, therefore,
equal to the sum of the principal or face value and
the interest earned.
Maturity (Future)Value

F = P(1 + rt)
Where;
F = maturity (future) value
P = principal
r = interest rate
t = term / time in years
Example
Find the maturity value if 1 million pesos is
deposited in a bank at an annual simple interest
rate of 0.25% after (a) 1 year and (b) 5 years?

Solution
Given: P = 1, 000, 000, r = 0.25% = 0.0025
Find: (a) maturity or future value F after 1 year
(b) maturity or future value F after 5 years
Maturity (Future)Value

Note: There are two ways to solve the problem.

Method 1: Solve the simple interest Is first and then
add it to P, that is, F = P + Is.
Method 2: Use the derived formula F = P(1 + rt).
 Maturity (Future)Value
1. When t = 1, the simple interest is given by

Method 1
Is = Prt = (1, 000, 000) (0.0025) (1) = 2, 500

The maturity or future value is given by F = P + Is = 1, 000, 000 + 2, 500 = 1, 002, 500

Method 2

To directly solve the future value F, F = P (1 + rt) = (1, 000, 000) (1 + 0.0025(1)) = 1, 002, 500

The future or maturity value after 1 year is P1, 002,500

Maturity (Future)Value
2. When t = 5,

Method 1
Is = P rt = (1, 000, 000)(0.0025)(5) = 12, 500
F = P + Is = 1, 000, 000 + 12, 500 = 1, 012, 500

Method 2
F = P(1 + rt) = (1, 000, 000)(1 + 0.0025(5)) = 1, 012, 500

The future or maturity value after 5 years is P1, 012,500.

Review
1. To buy a computer, Raquel borrowed 8,000 at 9% interest for 4
years. How much money did she have to pay back?
2. When Kevin bought a new office phone, he borrowed 9,200 at a
rate of 12% for 9 months. How much interest did he pay?
3. Julia put 1,000 into a savings account that earns 4% in interest.
How much will she have after 3 months?
4. When invested at an annual interest rate of 7%, an amount
earned P11, 200 of simple interest in two years. How much money
was originally invested?
Compound
Interest
Compound Interest
Many bank savings accounts pay compound interest. In
this case, the interest is added to the account at regular
intervals, and the sum becomes the new basis for
computing interest. Thus, the interest earned at a certain
time interval is automatically reinvested to yield more
interest.
The following table shows the amount at the end of
each year if principal P is invested at an annual interest rate
r compounded annually. Computations for the particular
example P = P100, 000 and r = 5% are also included.
Compound Interest
Principal = P Principal = 100,000
Int. rate = r compounded annually Int. rate = 5% compounded
Year (t)
annually
Amount at the end of the year Amount at the end of the year
1 𝑃 = 1+𝑟 =𝑃 = 1+𝑟 (100,000)(1.05) = 105, 000
2 𝑃 = 1 + 𝑟 (1 + 𝑟) = 𝑃 = (1 + 𝑟)2 (105,000)(1.05) = 110, 250
3 𝑃 = (1 + 𝑟)2 1 + 𝑟 = 𝑃 = (1 + 𝑟)3 (110,250)(1.05) = 121, 550.63
4 𝑃 = (1 + 𝑟)3 1 + 𝑟 = 𝑃 = (1 + 𝑟)4 (121, 550.63)(1.05) = 127, 628.16

Observe that the amount at the end of each year is just the amount from the
previous year multiplied by (1 + r). In other words, 1 + r is multiplied each time the year
ends. This results in the following formula for the amount after t years, given an annual
interest rate of r:
Maturity (Future) Value and Compound Interest
Maturity Value
𝑭 = 𝑷(𝟏 + 𝒓)𝒕
Where;
P = principal or present value
F = maturity (future) value at the end of the term
r = interest rate
t = term / time in years

Compound Interest
The compound interest Ic is given by
Ic = F – P
Maturity (Future) Value and Compound Interest
Maturity Value
𝒓
𝑭 = 𝑷(𝟏 + )𝒕𝒏
𝒏
Where;
P = principal or present value
F = maturity (future) value at the end of the term
r = interest rate
t = term / time in years
N= number of times the interest is compounded per year

Compound Interest
The compound interest Ic is given by
Ic = F – P
Example

Find the maturity value and the compound

interest if P10, 000 is compounded
annually at an interest rate of 2% in 5
years.
Solution
Given: P = 10, 000 r = 2% = 0.02 t = 5 years

Find: (a) maturity value F

(b) compound interest Ic

(a) F = P(1 + r)𝑡 = (10, 000)(1 + 0.02)5 = 11, 040.81

(b) Ic = F − P = 11, 040.81 − 10, 000 = 1, 040.81

The future value F is P11, 040.81 and the compound

interest is P1, 040.81.
Example

Suppose your father deposited in your bank

account P10, 000 at an annual interest rate of
0.5% compounded yearly when you graduate
from kindergarten and did not get the amount
until you finish Grade 12. How much will you have
in your bank account after 12 years?
Solution

Given: P = 10, 000 r = 0.5% = 0.005 t = 12 years

Find: F The future value F is calculated by

F = P(1 + r)𝑡 = (10, 000)(1 + 0.005)12 = 10, 616.78

The amount will become P10, 616.78 after 12 years

Present Value P at Compound Interest

𝑭
𝑷= 𝒕
= 𝑭(𝟏 + 𝒓)−𝒕
(𝟏 + 𝒓)

Where;
P = principal or present value
F = maturity (future) value at the end of the term
r = interest rate
t = term / time in years
Example
What is the present value of P50, 000 due in 7 years if money is
worth 10% compounded annually?

Solution
Given: F = 50, 000 r = 10% = 0.1 t = 7 years
Find: P
The present value P can be obtained by
𝐹 50,000
𝑃= = = 25, 657.91
(1+𝑟)𝑡 (1+0.1)7

The present value is P25, 657.91.

Example
Find the present value of P25, 000 due in 2 years if money is
invested at 10% compounded yearly.

Solution
Given: F = 25, 000 r = 10% = 0.1 t = 2 years
Find: P
The present value P can be obtained by
𝐹 25,000
𝑃= = = 20,661.16
(1+𝑟)𝑡 (1+0.1)2

The present value is P20,661.16.

Try this !
Future Value
If you deposit P6500 into an account paying 4% annual
interest compounded monthly, how much money will be in
the account after 4 years?

Present Value
Find the present value of P12, 000 due in 2 years if money is
invested at 5% compounded yearly.