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Simple Interest Example

A 2-year loan of $500 at 4% interest earned $40 in interest. A $1,200 investment at 6% for 4 months (1/3 year) earned $24 in interest. To calculate simple interest, the time must be converted to years if given in months by dividing by 12. The future value formula can be used to find the total repayment amount of a loan, such as the $16,000 total repayment on a $10,000 loan at 7.5% interest over 8 years.

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520 views3 pages

Simple Interest Example

A 2-year loan of $500 at 4% interest earned $40 in interest. A $1,200 investment at 6% for 4 months (1/3 year) earned $24 in interest. To calculate simple interest, the time must be converted to years if given in months by dividing by 12. The future value formula can be used to find the total repayment amount of a loan, such as the $16,000 total repayment on a $10,000 loan at 7.5% interest over 8 years.

Uploaded by

Kc De Lemos Tolen
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Example

A 2-year loan of $500 is made with 4% simple interest. Find the interest earned.

Solution
Always take a moment to identify the values given in the problem. Here we are given:

 Time is 2 years: t=2t=2


 Initial amount is $500: P=500P=500
 The rate is 4%. Write this as a decimal: r=0.04r=0.04
Now apply the formula:

I=Prt=500(0.04)(2)=40I=Prt=500(0.04)(2)=40
Answer: The interest earned is $40.
In this example, the time given was in years, just as in the formula. But what if you are only
given a number of months? Let’s use another example to see how this might be different.

Example
A total of $1,200 is invested at a simple interest rate of 6% for 4 months. How much interest is
earned on this investment?

Solution
Before we can apply the formula, we will need to write the time of 4 months in terms of years.
Since there are 12 months in a year:

t=412=13t=412=13
With this adjusted to years, we can now apply the formula
with P=1200P=1200 and r=0.06r=0.06.
I=Prt=1200(0.06)(13)=24I=Prt=1200(0.06)(13)=24
Answer: The interest earned is $24.
If you hadn’t converted here, you would have found the interest for 4 years, which would be
much higher. So, always make sure to check that the time is in years before applying the
formula.

Important! The time must be in years to apply the simple interest formula. If you are given
months, use a fraction to represent it as years.
Another type of problem you might run into when working with simple interest is finding the
total amount owed or the total value of an investment after a given amount of time. This is
known as the future value, and can be calculated in a couple of different ways.

Finding the future value for simple interest


One way to calculate the future value would be to just find the interest and then add it to the
principal. The quicker method however, is to use the following formula.

You know to use this formula when you are asked questions like “what is the total amount to be
repaid” or “what is the value of the investment” -anything that seems to refer to the overall total
after interest is considered.

Example
A business takes out a simple interest loan of $10,000 at a rate of 7.5%. What is the total amount
the business will repay if the loan is for 8 years?

Solution
The total amount they will repay is the future value, AA. We are also given that:
 t=8t=8
 r=0.075r=0.075
 P=10000P=10000
Using the simple interest formula for future value:

A=P(1+rt)=10000(1+0.075(8))=16000A=P(1+rt)=10000(1+0.075(8))=16000
Answer: The business will pay back a total of $16,000.
This may seem high, but remember that in the context of a loan, interest is really just a fee for
borrowing the money. The larger the interest rate and the longer the time period, the more
expensive the loan.

Also note that you could calculate this by first finding the interest, I = Prt = 10000(0.075(8)) =
$6000, and adding it to the principal of $10000. The final answer is the same using either
method.

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