Compund Interest

Compound Interest
Earned Interest as is added to the principal and the sum is treated as new principal for the calculation of the interest
for the next period.
Terms:
Compound Amount – It is the original amount plus the compound interest
Compound Interest – It is the difference between compound amount and the original principal.
Compounding – The interest is based on the present balance of principal.
Simple Interest vs. Compound Interest

Simple interest is computed based on the original principal, while compound interest is based on accrued principal.
Simple interest when due the interest becomes a non-interest bearing debt, while compound interest when it is
due, it is not paid rather it is added to become part of the principal. Compound interest can make a deposit or loan
increase higher at a faster rate compared to simple interest. The amount of increase in compound interest depends
on how often is the compounding, the more frequent times of compounding the higher the compound interest.
Pre-requisite:
1. Compare the simple interest and compound interest on a Php 15,000 loan at 8% annual interest for 3
years.
Solution
Computation of Simple Interest
I  Pr t
1st year of int erst
I  (15, 000)(0.08)(1)
I  Php 1, 200
2nd Year of Interest
I  (15, 000)(0.08)(1)
I  Php 1, 200
3rd Year of Interest
I  (15, 000)(0.08)(1)
I  Php1, 200
Total Interest  Php 3, 600
A  P  I  15, 000  3, 600  Php 18, 600
Computation of Compound Interest
I  Pr t
1st year of int est
I  (15, 000)(0.08)(1)
I  P hp 1, 200
F1  15, 000  1, 200  Php16, 200
2nd Year of Interest
I  (16, 200)(0.08)(1)
I  P hp 1, 296
F2  16, 200  1, 296  Php 17, 496
3rd Year of Interest
I  (17, 496)(0.08)(1)
I  Php 1,399.68
F3  17, 496  1, 200  Php18,895.68
F  Php 18,895.68
I  F  P  18,895.68  15, 000.00  Php 3,895.68
Analysis: The difference between simple and compound interest is that the amount of interest in simple interest is
constant for every interest period. While in compound interest, compounding every period, interest is added to
the principal that increases its value. In addition the compound interest is higher compared with simple interest.
Formula:
n
 r
F  P 1   , where n  m x t
 m
F = Compound Amount or Maturity
P = Present Value
r = rate of interest
m = number of interest period in one year
n = number of interest periods multiply by the number of terms in one
year (n = m x t)
t = terms in years
I F P
Interest Period (per year) m

Monthly 12
Quarterly 4
Semi-Annual 2
Annually 1
Another way of solving for the Compound Interest using the formula:
n
 r
F  P 1  
 m
n  mxt  1x3  3
3
 0.08 
F  15, 000 1  
 1 
F  Php 18,895.68
Solving for the Maturity Value (F)

Example:
1. Find the compound amount and the interest if Php 50,600 is invested at 9% compounded quarterly for 3
years and 3 months.
P = Php 56,600, r = 9% or 0.09, t = 3.25 years, m = 4

n  mxt  4 x3.25  13
n
 r
F  P 1  
 m
13
 0.09 
F  50, 600 1  
 4 
F  Php 67,573.07
I  F  P  67,573.07  50, 600
I  Php 16,973.07
2. Find the compounded interest of Php 60,800 for 4 years and 6 months at 6% converted semi-annually.
P = Php 60,800, r = 6% or 0.06, t = 4.5 years, m = 2

n  mxt  2 x 4.5  9
9
 0.06 
F  60,800 1  
 2 
F  Php 79,330.21
I  F  P  79,330.21  60,800
I  Php 18,530.21
Solving for the Present Value

Formula
n
 r
P  F 1   , where n  mxt
 m
Example
1. An obligation of Php 156,000 is due on January 14, 2015. What is the present value on October 14, 2008 at
5% compounded quarterly?
Year Month Day

2015 01 14
2008 10 14
Year Month Day

2014 13 14
2008 10 14
6 03 00 = 6 years and 3 months or 6.25 years
3
n  mxt  4 x6  25
12
n
 r
P  F 1  
 m
25
 0.05 
P  156, 000 1  
 4 
P  Php 114,353.33
2. What was the original amount invested 7 years ago at 7% if the maturity value is Php 550,000 compounded
semi-annually?
n  mxt  2 x7  14
n
 r
P  F 1  
 m
14
 0.07 
P  550, 000 1  
 2 
P  Php339, 780
Solving for the Time and Rate
Formula
Time
log( F  P)
t
 r
m log 1  
 m
 F 
r  m  n  1
 P 
Illustrative Example:
1. How long will Php 75,000 takes to amount to Php 96,000, if the interest is 7% semi-annually?
Given : P = Php 75,000, F = Php 96,000, r = 7% or 0.07, m = 2

log( F  P )
t
 r
m log 1  
 m
log(96, 000  75, 000)
t
 0.07 
2 log 1  
 2 
t  3.5879 years
or 3 years, 4 months and 1.644 days
2. When Php 80,000 due if the present value of Php 38,000is deposited in an investment firm at 8%
compounded monthly?
Given: P = Php 38,000, F = Php 80,000, r = 8% or 0.08, m = 12
log( F  P )
t
 r
m log 1  
 m
log(80, 000  38, 000)
t
 0.08 
12 log 1  
 12 
t  9.3365 years
or 9 years, 4 months and 1.14 days
3. Find the rate compounded quarterly if Php 3,500 accumulates to Php 15,800 in 5 years
P = Php 3,500, F = Php 15,800, t = 5, m = 4, n = mxt = 5(4) = 20
 F 
r  m  n  1
 P 
 15,800 
r  4  20  1
 3,500 
r  0.3131or 31.31%
4. At what interest rate will Php 8,120 amount to Php 12,250 in 4½ years compounded semi-annually?
P = Php 8,120, F = Php 12,250, t = 4.5, m = 2, n = mxt = 2(4.5) = 9

 F 
r  m  n  1
 P 
 12, 250 
r  2  9  1
 8,120 
r  0.0935 or 9.35%
Solving for the Nominal and Effective Rate

Nominal rate (j) is defined as the annual interest rate on which compound interest is computed while
effective rate (e) is interest rate compounded more than annually. The effective rate is higher than the nominal
rate.
If the rate is not specified as nominal or effective, it is assumed that the rate is nominal.
Formula
No min al Rate
1
j  m[(1  e) m  1]
Effective Rate
 j
m

e  1    1
 m  
Illustrative Example:
1. If the interest is compounded quarterly, find the nominal rate if the effective rate is 5%.
2. What nominal rate compounded monthly if the effective rate is 8.5%?
3. Find the effective rate of interest of 12% compounded semiannually.
4. Which interest is better? Solve for the effective rate:
a. 5% compounded quarterly or;
b. 4% compounded monthly.
Solution
1. e = 5% or 0.05, m = 4
1
j  m[(1  e)  1]
m
1
j  4[(1  0.05)  1]
4
j  0.0491or 4.91%
2. e = 8.5% or 0.085, m = 12
1
j  m[(1  e) m  1]
1
j  12[(1  0.085)12  1]
j  0.0819 or 8.19%
3. j = 12% or 0.12, m = 2
 j
m

e  1    1
 m  
 0.12 2 
e   1    1
 2  
e  0.1236 or 12.36%
4.
a. j = 5% or 0.05, m = 4
 j
m

e  1    1
 m  
 0.05  4 
e   1    1
 4  
e  0.051or 5.1%
b. j = 4% r 0.04, m = 12
 j
m

e  1    1
 m  
 0.04 12 
e   1    1
 12  
e  0.0407 or 4.07%
Therefore 5% compounded quarterly is better interest than 4% compounded monthly.
Name: __________________________________ Score: _______

Section: ___________ Instructor: _______________________ Date: ________
Activity 2.1B
COMPOUND INTEREST
Solve the following problem:

A. Compound Amount and Compound Interest
1. Accumulate Php 25,000 for 8 years at 6% compounded quarterly.
2. Find the amount due and interest for a loan of Php 50,500 at 5% compounded semi-annually for 6 years.
3. Jay invested Php 150,000 in a cooperative that offers 3% interest compounded quarterly. What sum of
money will he receive at the end of 7 years?

Compund Interest

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Compound Interest

Simple Interest vs. Compound Interest

Interest Period (per year) m

Solving for the Maturity Value (F)

P = Php 56,600, r = 9% or 0.09, t = 3.25 years, m = 4

P = Php 60,800, r = 6% or 0.06, t = 4.5 years, m = 2

Solving for the Present Value

Year Month Day

Year Month Day

Solving for the Time and Rate

Given : P = Php 75,000, F = Php 96,000, r = 7% or 0.07, m = 2

Given: P = Php 38,000, F = Php 80,000, r = 8% or 0.08, m = 12

P = Php 8,120, F = Php 12,250, t = 4.5, m = 2, n = mxt = 2(4.5) = 9

Solving for the Nominal and Effective Rate

Therefore 5% compounded quarterly is better interest than 4% compounded monthly.

Name: __________________________________ Score: _______

Solve the following problem:

1. Accumulate Php 25,000 for 8 years at 6% compounded quarterly.

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Name: ____________________________ Score: _