Lesson 01 - Simple Interest

It is a common belief that every person has debts, that even a newly-born child is already doomed to
pay the debts of his country; debts he is innocent of and knows nothing about. Some of us pay
interest in banks, to lending institutions and to individual lenders. Whether we receive interest or pay
interest for the money borrowed or invested, it is very essential for us to have a good understanding
of interest and how it is computed.

In the study of this discipline, the student will learn the Mathematical processes of calculating
interest of money that enables those with money to earn more money for themselves and utilized
such money for national economic development and growth, and those without money who resort to
borrow money from lending institutions or persons to know how much money they pay for the
interest.

Simple Interest

Business entrepreneurs and private individuals who find themselves in need of cash or financial
credit borrow money and agree to pay a certain percentage for the privilege of using the borrowed
amount. This activity of borrowing money should be beneficial to borrower since he can invest the
money borrowed on some profitable business. Likewise, the lender or the investor benefits from this
transaction because he is able to earn an amount for the charge fee for the use of his money which
is the interest paid by the borrower.

Definition of Terms

INTEREST (I)_– When people borrow money from someone or lending any institution
PRINCIPAL(P) – The money borrowed or amount of money invested
RATE OF INTEREST(r) – The per cent of interest that is paid on the loan
TIME or TERM (t) – The period of the loan
FINAL AMOUNT (F)– The money borrowed plus the interest it bears

SIMPLE INTEREST

Simple Interest is an interest in which only the original principal bears interest of the entire term of
the loan. It is defined as the product of the principal, rate and time. It is given by the formula:

I = Prt

Where:

I = Simple Interest

P = Principle
r = rate of percent principle which is to be paid per unit of time

t = unit of time usually expressed in years of fractional parts of a year

From the Simple Interest formula which is I = Prt, we can derive the following formulas.

P = I/Rt

R = I/Pt

T = I/Pr

To determine the final amount or maturity value at the end of the term, the following formulas can be
used;

F=P+I

I=F–P

Since I = Prt, F can be expressed as:

F = P (1 + rt)

The term may be stated in any of the following ways:

1. When time is expressed in number of year(s),

I = P x r x number of year(s)

2. When time is express in number of month(s)

I = P x r x number of month(s)

3. When time is expressed in number of days, there are two ways to compute for the interest,
namely:
Ordinary interest
Io = P x r x (number of days/360)

Exact interest
Io = P x r x (number of days/365)

EXAMPLES:

A man borrowed P6,000 from the bank at 8% simple interest. What is the simple interest and final
amount he will be pay after 2 years?
Solution:

Given: P = P6,000 r = 8% t = 2 years

I = Prt F=P+I

= (P6,000) (0.08) (2) = P6,000 + P960

= P960 = P6,960

Find the interest and amount on P5,900 at 6 ¾% simple interest for 9 months.
Solution:

Given: P = P5,900 r = 6 3?4% t = 9 months

I = Prt F = P+I

= (P5,900) (6 ¾%) (9) = P5,900 + P298.69

= P298.69 = P6198.69

3. A man paid P10,600 on a loan made 3 years ago at 7 ½% simple interest. Find the original
amount of the loan.

Solution:

Given: F = p10, 600 r = 7 ½% t = 3 years find P;

P = F/1 + rt
 = P10, 600/ 1 (0.075) (3)

= P8, 653.06

4. Vexana borrowed P10,000 from a multi-purpose cooperative charging 12% simple interest with an
agreement of paying the principal and the interest at the end of the term. If she paid P13,500 on the
maturity date, how long did she use the money?

Given: P = P10,000 F = P13, 500 r = 12% find t;

Solution:

I=F–P t= I/Pr

= P13, 500 – P10, 000 = P3, 500/ (P10, 000)(0.12)

= P3, 500 = 2.92 years

COMPOUND INTEREST
DEFINITION OF TERMS

COMPOUND AMOUNT – the sum due at the end of the transaction, designated by F.
COMPOUND INTERST – the difference between the principal and the compound amount.
INTEREST PERIOD – the time between two successive conversions
FREQUENCY CONVERSION – the number of periods in one year, the frequency conversion is
denoted by m.

NOTE:
Annually m=1
Semi – annually m = 2
Quarterly m=4
Monthly m = 12

The annual interest rate is called the nominal rate, denoted by j. The interest rate per period,
denoted by I, is the nominal rate j divided by the frequency of conversions m, that is,

Interest rate per period = nominal rate / frequency rate

The time is given in years. The number of conversions during the term, denoted by n, is
determined by multiplying the time by the frequency of conversion, that is:
n=txm
Compound Amount
Formula: F = P (1 + I)n

Compound Interest
Formula: I = F – P

Where,
F = Final amount or compound amount
P = Original Principal
i = Periodic rate
n = total number of conversion periods for the whole team
I = Compound Interest

EXAMPLES:
1. Find the compound amount and interest on P10,000 at 5% compounded quarterly for 3
years.
Given: P10,000 j = 5% t = 3 years m = 4
Find: F & I
Solution:
i = j/m = 5%/4 = 1 ¼%
n = t x m = (3)(4) = 12
F =P (1 + i)n
= P (10,000 [1+ 0.0125]12
= P11,607.55

I=F–P
= P11,607.55 – P10,000
= P1,607.55
2. How much is needed to accumulate P15,000 in 16 months if the interest rate is 8%
compounded semi-annually?
Given: F = P15,000 j = 8% m = 2 t = 16 months
Find: P
Solution:
i = j/m = 8%/2 = 4%
n = t x m = (1.33) (2) = 2.66
P = 𝐹 / (1+𝑖) 𝑛
= 𝑃15,000 / (1+0.04) 2.66
= 𝑃15,000 / 1.109963461
= P13, 513. 96

3. At the birth of her son, George, how much should a mother deposit in the bank to give
her son with P50,000 on his 15th birth day if money is worth 12% compounded monthly?
Given: F = P50,000 t = 15 years m = 12 j = 12%
Find: P
Solution:
i = j/m = 12%/12 = 1%
n = t x m = (15) (12) = 180
P = 𝐹 / (1+𝑖)𝑛
= 𝑃50,000 / (1+0.01) 180
= 𝑃15,000 / 5.995801975
= P8,339.16

Interest Rate and Time

EXAMPLES:
1. Find the rate compounded monthly if P5,000 accumulates to P6,5000 in 2 years and 3
months.
Given: P = P5,000 F = P6,500 t = 2 yrs & 3 months m = 12
Find: j
Solution:
n = t x m = (2 3/12) (12) = 27
F = P(1 + i)n
P6,500 = P5,000 (1+i)27
1.3 = (1 + i)2
1+i = (1.3) 1/27
1+i = 1.00976456
i = 1.00976456 – 1
i = 0.00976456
But:
j=ixm
= (0.00976456)(12)
= 11.72%
Alternative Solution:
J = m[(F/P)1/n – 1]
= 12 [(P6,500/P5,000)1/27 – 1]
= 12(1.00976456 – 1)
= 11.72%

2. How long will it take for P8,600 to amount to P15,000, if invested at 10%, m = 4
Given: P = P8,6000 F = P15,000 j = 10% m = 4
Find: t
Solution:
i = j/m = 10%/4 = 2.5%
F = P(1+i)n
P15,000 = P8,600 (1 + 0.025)n
1.744186047 = (1.025)n
n log 1.025 = log 1.744186047
n = log 1.744186047 / log1.025
n = 22.53
but:
t = n/m
= 22.53/4
= 5.63 years
Alternative Solution:
t = log𝐹−log 𝑃 / 𝑚 log(1+𝑖)
= log𝑃15,000−log 𝑃8,600 / 4 log(1+0,025)
= 4.176091259−3.934498451/ 4(0.010723865)
t = 5.63 years