Types of Compound Interest Formulas

7. Uniform Gradient Series Annual Equivalent Amount:

• The objective of this mode of investment is to find the annual
equivalent mode of a series with an amount A1 at the end of first
year and with an equal increment (G) at the end of each of the
following n-1 years with the interest rate i % compounded annually.

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 Types of interest factor
1. A person is planning for his retired life. He has 10 more years of service. He would
like to deposit 20% of his salary, which is Rs 4,000 at the end of the first year and
thereafter he wishes to deposit the amount with an annual increase of Rs. 500 for the
next 9 years with an interest rate of 15%. Find the total amount at the end of the 10th
year of the above series.

A1 = Rs. 4,000 G = Rs. 500, i = 15%

n = 10 years, A = ? & F = ?

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 Types of interest factor
2. A person is planning for his retired life. He has 10 more years of service. He would
like to deposit Rs. 8,500 at the end of the first year and thereafter he wishes to deposit
the amount with an annual decrease of Rs. 500 for the next 9 years with an interest
rate of 15%. Find the total amount at the end of the 10th year of the above series .

A1 = Rs. 8,500 G = - Rs. 500, i = 15%

n = 10 years, A = ? & F = ?

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 Practice Problems
3. The following cash flow diagrams are said to be equivalent in terms of economic
desirability at an interest rate of 12% compounded annually. Determine the unknown
value A?

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 Practice Problems
• Gerri, an engineer at Fujitsu, Inc., has tracked the average inspection cost on a
robotics manufacturing line for 8 years. Cost averages were steady at $100 per
completed unit for the first 4 years but have increased consistently by $50 per unit
for each of the last 4 years. Taking interest rate as 10% calculate its present worth.

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 Practice Problems
• Calculate the present worth, future worth, and annual worth for the following series
of incomes and expenses, if the interest rate is 10% per year.

Annual Worth
A = 8000(A/P,10%,10) + 600
= 8000(0.16275) + 600
= $1902
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 Practice Problems

• Suppose that you have a savings plan covering the next ten years,
according to which you put aside $600 today, $800 at the end of
every year for the next five years, and $2000 at the end of every year
for the remaining five years. As part of this plan, you expect to
withdraw $300 at the end of every year for the first 3 years, and
$350 at the end of every year till 10th year. In addition to this you are
expected to withdraw an amount of $50 at the end of every 2 years
(starting from 2 year end) till 15th year. Assume interest to be 12%.
• Draw the cash flow diagram.
• Find the amount accumulated in the saving account at the end of 15th 7
year.
 Nominal Interest rates

• Interest rate are normally calculated on an annual basis.

• However interest may be compounded several times in an year

quarterly, half yearly or monthly etc. this is nominal interest rate.

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 Nominal Interest rates
Nominal interest rate = rate per year /number of times compounds in an year

i = r/n
• Interest charged is always represented on annual basis.
• For example: if one year is divided in to 4 quarters and each quarter is
charged with an interest rate of 2% then it is stated as
• 8% per year compounded quarterly or 8% compounded quarterly
Problems:
• The future worth at the end of one year for Rs 1000 earning an interest rate
of 8% compounded quarterly is Rs. 1082.43
• If the interest rate is 8% compounded annually then future worth is Rs. 1080
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• Comparing the results nominal interest rate gives higher results.

 Effective interest rates

• It is the ratio of interest charge for 1year to the principal.

i effective = [(F – P)/ P]*100

• Effective annual interest rate is (1 + r/n)n – 1

• Where , r- nominal interest rate

n- number of compounding periods per year

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 Practice Problems
• Jacki obtained a new credit card from a national bank, MBNA, with a stated rate of
18% per year, compounded monthly. For a $1000 balance at the beginning of the
year, find the effective annual rate and the total amount owed to MBNA after 1 year,
provided no payments are made during the year.

Solution: There are 12 compounding periods per year (n=12)

Effective annual interest rate = (1 + r/n)n – 1

ieff = [(1 + (18%/12) )12 -1 ] * 100
ieff =19.562%

Jacki will pay 19.562%, or $195.62 plus the $1000 balance, for the use of the bank's 11
money during the year.
 Practice Problems

• A company is planning to invest Rs. 6000 once in 6 months, the

investment is made at the end of every 6th month, for next 5 years.
The company is planning to utilize this amount accumulated at the
end of 5th year for buying an asset. Identify the amount accumulated
at the end of 5th year under following cases:
• If interest is 12% compounded semi-annually.
• If interest is 12% compounded annually.
• If interest is 12% compounded quarterly.

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• Visteon, a spin-off company of Ford Motor Company, supplies major
Practice Problems
automobile components to auto manufacturers worldwide and is
Ford's largest supplier. An engineer is on a Visteon committee to
evaluate bids for new-generation coordinate-measuring machinery to
be directly linked to the automated manufacturing of high-precision
components. Three vendor bids include the interest rates. Visteon
will make payments on a semi-annual basis only. The engineer is
confused about the effective interest rates. What they are annually
and over the payment period (PP) of 6-months.
• Bid 1: 9% per year, compounded quarterly
• Bid 2: 3% per quarter, compounded quarterly
• Bid 3: 8.8% per year, compounded monthly
• Determine the effective rate for each bid on the basis of semi-annual
payments, and construct cash flow diagrams for each bid rate.
• What are the effective annual rates? These are to be a part of the final
bid selection. 13

• Which bid has the lowest effective annual rate?

 Practice Problems
• A dot-com company plans to place money in a new venture capital fund that
currently returns 18% per year, compounded daily. What effective rate is this (a)
yearly and (b) semiannually?.

a)

b)

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 Practice Problems
• A company wants to have Rs. 100000 available at the end of 5 years so as to replace
a certain machine. Determine the lump sum amount the company should deposit
now if the interest rate in years 1, 2, 3, 4, and 5 are 10%, 11%, 12%, 13%, and 14%
respectively.

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 Practice Problems
• An entrepreneur intending to start a new business knows that the first few years
were most difficult. To lessen the chance of failure a loan plan for startup capital is
proposed in which interest paid during the first two years will be 3% and 6% for the
next two years and 12% for the last two years. How large a loan can be sanctioned
if proposed repayments at the end of years 2, 4 , and 6 are Rs. 20000, Rs. 30000,
and Rs. 50000 respectively.

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