INTERESTS

Engineering Economics - 2nd Semester (2022-2023)

Interests
 Interest is the amount of money paid for the use of borrowed capital or the income produced by money
which has been loaned. Mathematically, it is the difference between an ending amount of money and
the beginning amount.

 When interest paid over a specific time unit is expressed as a percentage of the principal, it is called the
interest rate.

Cash Flow Diagrams (Example)

 View of Lender

 View of Borrower

Simple Interests
 Simple interests is calculated using the principal only, ignoring any interests that had been accrued in
preceding periods.
I – interest
I = Pin P – principal or present worth
F=P+I n – number of interests periods
F = P (1 + in) i – rate of interests
F – future worth
Ordinary Simple Interests
 Ordinary simple interests is computed on the basis of 12 months of 30 days or 360 days a year.

Exact Simple Interests

INTERESTS
Engineering Economics - 2nd Semester (2022-2023)
 Exact simple interests is based on the exact number of days in a year, 365 days in ordinary year and
366 for a leap year.

Compound Interests
 In calculations of compound interest, the interests for an interest period is calculated on the principal
plus total amount of interest accumulated in previous period.
F=P=I
F=P(1+i)ⁿ
 The quantity (1+i)n is commonly called the “single payment compound amount factor” and is
designated by the functional symbol F/P, i%, n

F=P ( FP ,i % , n)
Interest Rates
 Nominal rate of interest specifies the rate of interest and a number of interest periods in one year.
i – rate of interests per interest period r
r – nominal interest rate i=
m
m – number of compounding periods per year

 Effective rate of interest is the actual interest or exact rate of interest on the principal during one year.

i – rate of interests per interest period

Effective rate= 1+ ( ) r m
m
−1

r – nominal interest rate

m – number of compounding periods per year

Compounding
 In discrete compounding, the interest is compounded at the end of each finite – length period, such
as month, a quarter or a year.

( )
nm
r
F=P 1+
m
 In continuous compounding, it is assumed that cash payments occur once per year, but the
compounding is continuous throughout the year.

Compounded Continuously
12
rn
F=Pe 10

2
INTERESTS
Engineering Economics - 2nd Semester (2022-2023)