Module 2

INTEREST & MONEY – TIME

RELATIONSHIPS
Simple Interest

 Interest – is the return on

capital or cost of using capital.
It is the amount of money paid
𝐈=𝐏𝐢𝐧 𝐅=𝐏+𝐈
for the use of borrowed capital
or the income produced by
money, which has been loaned.
𝐅=𝐏(𝟏+𝐢𝐧)
 Simple Interest – is calculated Where:
I = interest
using the principal only, i = rate of interest
ignoring any interest that had n = number of interest period
been accrued in preceding P = principal or present worth
F = accumulated amount or future
period. worth
Types of Simple Interest

1. Ordinary Simple Interest – simple interest in which

it is assumed that each month contains 30 days and
consequently each year has 360 days.

1 month = 30 days
1 year = 360 days (banker’s year)

2. Exact Simple Interest – simple interest in which the

exact number of days per month is used.

1 ordinary year = 365 days

1 leap year = 366 days
 Problem

You borrow from JBT Lending Investor the amount of P5000 for 5 years
at a simple interest rate of 8% per year. How much interest will JBT Lending
Investor receive from the loan'? How much will you pay you at the end of 5
years?

Solution:
 2. Determine the exact simple interest on P2,000,000 invested for the
period from October 24, 1987 to January 7, 1990; if the rate of interest
is 20%.
Solution:

Total number of interest days 806 days

𝑇𝑜𝑡𝑎𝑙𝑛𝑢𝑚𝑏𝑒𝑟𝑜𝑓𝑑𝑎𝑦𝑠𝑓𝑟𝑜𝑚1987𝑡𝑜1990=365+366+365+365=1461𝒅𝒂𝒚𝒔
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 Compound Interest

Compound Interest – the

interest for an interest 𝐧 𝐫
period is calculate on the 𝐅=𝐏(𝟏+𝐢) 𝐢=
𝐦
principal plus total amount of

𝐧=𝐦×𝐭
interest accumulated in the −𝐧
previous period. Compound 𝐏=𝐅(𝟏+𝐢)
interest means “the interest
on top of interest.” Where:
I = interest
i = rate of interest
n = number of interest periods
m = number of compounding periods
t = time
P = present worth
F = future worth
Rates of Interest
 Rate of Interest – it is the cost of borrowing money.

 Nominal Rate of Interest – it specifies the rate of interest and

a number of interest periods in one year.

𝐫 Where:
𝐢= i = interest rate per interest period
𝐦 r = nominal interest rate
m = number of compounding periods

 Effective Rate of Interest – it is the actual or exact rate of

interest on the principal during one year.

𝐄𝐑=(𝟏+𝐢)𝐦 −𝟏 Where:
ER = effective rate

( )
𝐦 i = interest rate per interest period
𝐫 r = nominal interest rate
𝐄𝐑 = 𝟏+ −𝟏 m = number of compounding periods
𝐦
Values of “m”
 m = 1 for compounded annually (every 12 months)
 m = 2 for compounded semi-annually (every 6 months)
 m = 4 for compounded quarterly (every 3 months)
 m = 6 for compounded bi-monthly (every 2 months)
 m = 8 for compounded semi-quarterly (every 1 1/2
months)
 m = 12 for compounded monthly (every month)
 m = 24 for compounded semi-monthly (every 1/2 month)
 F/P and P/F Factors:
Notation and Equations

Factor Factor Standard Equation

Excel
Find/Given Notation with Factor
Notation Name Functions
Equation Formula

Single-
payment
(F/P,i,n) F/P F = P(F/P,i,n) F = P(1 + i)n FV(i%,n,,P)
compound
amount
Single-
payment
(P/F,i,n) P/F P = F(P/F,i,n) P = F(1 + i)-n PV(i%,n,,F)
present
worth
 𝑃𝑟𝑜𝑏𝑙𝑒𝑚𝑠
A P2000 loan was originally made 8% simple interest for 4 years. At the end of this
period the loan was extended for 3 years, without the interest being paid, but the new
interest rate was made 10% compounded semi annually. How much should the
borrower pay at the end of the 7 years?

𝑆𝑜𝑙𝑢𝑡𝑖𝑜𝑛

𝐶𝑎𝑠h 𝑓𝑙𝑜𝑤 𝑑𝑖𝑎𝑔𝑟𝑎𝑚

𝐺𝑖𝑣𝑒𝑛:
𝑃=2 , 000 𝑛𝑐 =3 𝑦𝑟𝑠
𝑖𝑠 =8 % 𝑟 𝑐 =10 %  𝑐𝑜𝑢𝑚𝑝𝑜𝑢𝑛𝑑𝑒𝑑 𝑠𝑒𝑚𝑖 𝑎𝑛𝑛𝑢𝑎𝑙𝑦
𝑛𝑠 =4 𝑦𝑟𝑠 𝐹 7 =?
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2. What nominal rate of interest compounded quarterly can be used instead
of 8% compounded monthly. (r =8% compounded monthly but the required
interest rate, i, is per quarter.)

𝑆𝑜𝑙𝑢𝑡𝑖𝑜𝑛

𝐸𝑅𝑚𝑜𝑛𝑡h𝑙𝑦 =𝐸𝑅 𝑞𝑢𝑎𝑟𝑡𝑒𝑟𝑙𝑦

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Which is better for an investor, to invest at 5 ½% compounded semi-annually
as 5% compounded monthly?

Given:
i1 = 5.5%
i2 = 5%
m1 = compounded semi annually
m2 =compounded annually

Solution:

ER semi-annually = ER monthly

𝑇h𝑢𝑠

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An investor wishes to deposit an amount now so that in 30 years P1, 000,000
will be in an account that pays 10% interest per year, compounded annually.
What amount must be deposited now?

Solution:

Given
F = P1, 000,000
n = 30 yrs

P = F (1 + i) –n
P = 1, 000,000 (1 + 0.10)-30
P = 1, 000,000 (1.10) -30
P = 57, 309.00

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 By the condition of a will the sum of P25, 000 is left to be held in trust by
her guardian until it amounts to P45, 000. When will the girl receive the
money if the fund is invested at 8% compounded quarterly?

𝑆𝑜𝑙𝑢𝑡𝑖𝑜𝑛
Given:
P = P25, 000
𝑎¿ 𝐹 =𝑃 ¿

i=%
i = 2%
F = P45, 000
m=4

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𝑆𝑜𝑙𝑢𝑡𝑖𝑜𝑛

Given:
P = P500
i = 7%
F = P2, 000

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Cash Flow Diagram

 Cash Flow Diagram – depicts the timing and

amount of expenses (negative, downward) and
revenues (positive, upward) for engineering
projects.

Receipt (positive cash

flow or cash inflow

Disbursement (negative
cash flow or cash outflow
Types of Cash Flow
Diagrams
P-Pattern “present”
1 2 3 n

F-Pattern “future”
1 2 3 n

A-Pattern “annual”
1 2 3 n

G-Pattern “gradient”
1 2 3 n
Equation of Value
An equation of value is obtained by setting the sum of the
values on a certain comparison or local date (or focal date)
of one set of obligations equal to the sum of the values on
the same date of another set of obligations.

Steps in Solving Equation of Value:

1. Draw the cash flow diagram.
2. Select any convenient focal date.
3. Years on the left of the focal date have a positive sign
while years on the right of the focal date have a
negative sign.
4. Use the principle: Cash Inflow = Cash Outflow
 Discrete Payments

The solution of discrete payments or number of

transactions occurring at different periods is taking
each transaction to the base year and equating each
value.
Continuous Compounding Interest
In continuous compounding, it is assumed that cash payments occur once per
year, but the compounding is continuous throughout the year.
Compare the accumulated amounts after 5 years of P1,000 invested at the rate of 10%
per year compounded (a) annually, (b) semiannually, (c) quarterly, (d) monthly, I daily,
and (f) continuously.

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Discount
It is the interest paid in advanced or the future worth of the negotiable paper
minus its present worth. In terms of goods it is the deduction in percentage from the
original price offered by the supplier.
The rate of discount is the discount on one unit of principal per unit of time.

Where:

Inflation
Inflation is the rate at which the level of prices for goods and services is
increasing and, subsequently, the buying power of money is decreasing
 

Where:
FC = future cost of the same commodity
PC = present cost of a commodity
F = annual inflation rate
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 A man bought a lot worth P1, 000,000 if paid in cash. On the installment basis, he paid
a down payment of P200,000; P300,000 at the end of one year, P400,000 at the end of
three years and a final payment at the end of five years. What was the final payment if
interest was 20%.

𝑆𝑜𝑙𝑢𝑡𝑖𝑜𝑛

 Using today as the focal date, the equation

of value is

𝑁𝑜𝑡𝑒:
P = F(1+ P = F (P/F i% n)

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24
 Mr. J. de la Cruz borrowed money from a bank. He received from the
bank P1, 342 and promises to repay P1, 500 at the end of 9 months.
Determine the simple interest rate and the corresponding discount rate
or often referred to as the “Banker’s discount.”

𝐺𝑖𝑣𝑒𝑛
𝑆𝑜𝑙𝑢𝑡𝑖𝑜𝑛
P = 1, 342

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A man deposits P50, 000 in a bank account at 6% compounded monthly for 5 years.
If the inflation rate of 6.5% per year continues for this period, will this effectively
protect the purchasing power of the original principal?
Given:
P = present worth = P50, 000
r = nominal rate of interest = 6% compounded monthly
n = number of years = 5 years
f = inflation rate = 6.5%
Required:
F = future worth

Solution:
a) Solve for i

m
–1
 
= (1 + 0.06/12) 12 – 1
 
= 0.061677 or 6.1677%
 
b) Future worth
F = P( m
= 50, 000 (5 26

= P49, 225
 Banker’s Discount
Certain banks lend money in such a way that they
deduct the interest on the money. They actually don’t
lend you money you asked for. This type of computing
money is called banker’s discount. The money received
by the borrower after the discount has been deducted
is called proceeds.

−𝐧 Where:
𝟏−(𝟏+𝐧𝐢) i = rate of interest
𝐝= d = rate of discount
𝐧 n = number of interest period
 Exercises
A man borrowed P5,000 from a bank and agreed to pay the loan at the
end of 9 months. The bank discounted the loan and gave him P4,000 in
cash. (a) What was the rate of discount? (b) What was the rate of
interest? (c) What was the rate of interest for one year?

A student plans to deposit P1, 500 in a bank now and another P3,000
for the next two years. If he plans to withdraw P5, 000 three years
after his deposit for the purpose of buying shoes. What will be the
amount of money left in the bank one year after his withdrawal?
Effective rate is 10%.

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Sample Problems on
Continuous Compounding Interest

1. Philip invested $100 on a bank. The bank offers

5% interest compounded continuously in a
savings account. Determine (a) how long will it
require for him to earn $5 (b) the equivalent
simple interest rate for 1 year of the bank.
2. Which is more advisable to invest Php5,000 for
five (5) years, to bank A that offers 5%
compounded continuously or to bank B that
offers 10% simple interest?
Sample Problems on
Banker’s Discount
1. Ms. Glydel Marquez borrowed money from a bank.
She received from the bank Php1,342 and
promised to repay Php1,500 at the end of 9
months. Determine the following: (a) simple
interest rate (b) discount rate or often referred
as Banker’s discount.
Sample Problems on
Equation of Value
1. Jay wishes his son, Jason, to receive
Php1,000,000 twenty years from now. What
amount should he invest now, if it will earn
interest of 12% compounded annually during the
first five years and 10% compounded monthly for
the remaining years.
2. Find the present worth of a future payment of
Php300,000 to be made in 10 years with an
interest rate of 10% compounded annually. What
will be the amount if it will be paid 5 years later
(on the 15th year)?
 Sample Problems on
Compound Interest
1. What rate of interest compounded annually must be received if an
investment of Php5,400 made now will result in a receipt of
Php7,200 5 years hence?
2. What amount will be accumulated by Php4,100 in 10 years at 6%
compounded annually?
3. What effective annual interest rate corresponds to the following
situations?
a. nominal interest rate of 10% compounded semi-annually
b. nominal interest rate of 6% compounded monthly
c. nominal interest rate of 8% compounded quarterly
4. How much should Engr. Cruz deposit now, if after 10 years, this
will amount to Php100,000. Interest rate is 12% compounded
semiannually?
5. If Php1,000 becomes Php5,734 after 15 years, when invested at an
unknown rate of interest compounded semi-annually, determine
the unknown nominal rate and corresponding effective rate.
Sample Problems on
Discrete
1.
Payments
Acosta Holdings borrowed Php9,000 from Smith Corporation on
January 1, 1998 and Php12,000 on January 1, 2000. Acosta
Holdings made a partial payment of Php7,000 on January 1,
2001. It was agreed that the balance of the loan would be
amortized by two payments, one on January 1, 2002 and one on
January 1, 2003, the second being 50% larger than the first. If
the interest rate is 12%, what is the amount of each payment?
2. A contract has been signed to lease a restaurant at Php20,000
per year with annual increase of Php1,500 for 8 years. Payments
are to be made at the end of each year, starting one year from
now. The prevailing rate is 7%. What lump sum paid today
would be equivalent to the 8 year lease program?
3. Mr. Cruz buys a second hand car worth Php150,000 if paid in
cash. On installment basis, he pays Php50,000 downpayment,
Php30,000 at the end of one year, Php40,000 at the end of two
years and a final payment at the end of four years. Find the
final payment if interest is 14%.