MODULE 2 Cont……..

2.2 Marginal Analysis

Marginal analysis is an examination of the associated costs and potential benefits of specific business activities or
financial decisions. The goal is to determine if the costs associated with the change in activity will result in a benefit
that is sufficient enough to offset them. Instead of focusing on business output as a whole, the impact on the cost of
producing an individual unit is most often observed as a point of comparison. Marginal analysis can also help in the
decision-making process when two potential investments exist, but there are only enough available funds for one.
By analyzing the associated costs and estimated benefits, it can be determined if one option will result in higher
profits than another.

2.2.1 Marginal Analysis and Observed Change

From a microeconomic standpoint, marginal analysis can also relate to observing the effects of small changes within
the standard operating procedure or total outputs. For example, a business may attempt to increase output by 1%
and analyze the positive and negative effects that occur because of the change, such as changes in overall product
quality or how the change impacts the use of resources. If the results of the change are positive, the business may
choose to raise production by 1% again, and reexamine the results. These small shifts and the associated changes
can help a production facility determine an optimal production rate.

Rules of Marginal Analysis

When performing marginal analysis, there are two profit maximization rules to consider. These two rules dictate the
point at which companies should manufacture goods and allocate resources.

Rule #1: Operate Until Marginal Cost Equals Marginal Revenue

The overarching rule of marginal analysis is that it is usually in a company's best interest to perform an activity as
long as the marginal revenue is greater than the marginal cost. When marginal revenue and marginal cost are equal,
there is theoretically no financial incentive for the company to continue the activity, though there may be non-
financial factors to consider.

Consider a manufacturing example where it costs ₦20 to make a good whose marginal revenue is ₦50. For this
unit, the company makes ₦30. If the next unit costs ₦40 to make, the company still earns a marginal profit because
marginal revenue of ₦50 is greater than the marginal cost. If the next unit were to cost ₦60 to make, it would no
longer be financially feasible to make and sell the good. The point at which marginal revenue and marginal cost
intersect is often called marginal equilibrium. It is the point at which total company profit is maximized, even if unit
profit is not at its highest.

Rule #2: Equalize Marginal Return across Products

Another important rule related to marginal analysis relates to companies that have different products. If a company
chooses to only dedicate resources to one product, the potential marginal revenue of the other products is foregone
in favor of a product likely with a diminishing marginal profit. To avoid this, every product should have equal
marginal revenue to maximize the amount of benefit obtained, especially if there are resource constraints at play.

Consider the table below outlining the marginal return received from two products. If one unit of Product A is
consumed, the consumer receives a marginal benefit of 100. If a third unit of Product B is consumed, the consumer
receives a marginal benefit of 30 for that third unit.
Table 1. Marginal Analysis Example (units unspecified)

Units Consumed Product A Product B

1 +100 +50

2 +25 +40

3 +10 +25

4 +5 +15

Based on the table 1, this second rule would dictate that the first unit consumed should be one unit of Product A.
However, we now know the marginal return of a second unit of Product A only yields a return of 25. This second
rule would call for the consumer to consume units of Product B until the marginal revenue of the two products meet.
In this example, the highest return would occur after 1 unit of Product A and 3 units of Product B have been
consumed.

2.2.2 Marginal Cost vs. Marginal Benefit

Marginal cost is the cost to produce one additional unit of production. It is an important concept in cost accounting
as marginal cost helps determine the most efficient level of production for a manufacturing process. It is calculated
by determining what expenses are incurred if only one additional unit is manufactured. A marginal benefit (or
marginal product) is an incremental increase in a consumer's benefit in using an additional unit of something. A
marginal cost is an incremental increase in the expense a company incurs to produce one additional unit of
something. Marginal benefits normally decline as a consumer decides to consume more and more of a single good.
For example,

a company has captured economies of scale, the marginal costs decline as the company produces more and more of
a good. For example, a company is making fancy gadget that are in high demand. Due to this demand, the company
can afford machinery that reduces the average cost to produce each gadget; the more they make, the cheaper they
become. On average, it costs ₦50 to produce a single gadget, but because of the new machinery, producing the 101st
gadget only costs ₦1. Therefore, the marginal cost of producing the 101st widget is ₦1. Imagine a company that
manufactures high-quality exercise equipment. The company incurs both fixed costs and variable costs, and the
company has additional capacity to manufacture more goods. Let's say it cost the company $500,000 to manufacture
1,000 exercise bikes. The company has determined it will cost an additional $400 to manufacture one additional
bike. Although the average unit cost is $500, the marginal cost for the 1,001th unit is $400. The average and
marginal cost may differ because some additional costs (i.e. fixed expenses) may have been incurred as additional
units are manufactured.

The change in total expenses is the difference between the cost of manufacturing at one level and the cost of
manufacturing at another. For example, management may be incurring ₦1,000,000 in its current process. Should
management increase production and costs increase to ₦1,050,000, the change in total expenses is ₦50,000
(₦1,050,000 - ₦1,000,000).

The change in quantity of units is the difference between the number of units produced at two varying levels of
production. Marginal cost strives to be based on a per-unit assumption, so the formula should be used when it is
possible to a single unit as possible. For example, the company above manufactured 24 pieces of heavy machinery
for ₦1,000,000. The increased production will yield 25 total units, so the change in quantity of units produced is 1
(i.e 25 - 24).
 2.2.3 Marginal Cost Formula

Marginal cost is calculated as the total expenses required to manufacture one additional good. Therefore, it can be
measured by changes to what expenses are incurred for any given additional unit.

Marginal Cost = Change in Total Expenses / Change in Quantity of Units Produced

The formula above can be used when more than one additional unit is being manufactured. However, management
must be mindful that groups of production units may have materially varying levels of marginal cost.

2.2.3 Example of Marginal Analysis in Manufacturing

When a manufacturer wishes to expand its operations, either by adding new product lines or increasing the volume
of goods produced from the current product line, a marginal analysis of the costs and benefits is necessary. Some of
the costs to be examined include, but are not limited to, the cost of additional manufacturing equipment, any
additional employees needed to support an increase in output, large facilities for manufacturing or storage of
completed products, and as the cost of additional raw materials to produce the goods.

Once all of the costs are identified and estimated, these amounts are compared to the estimated increase in sales
attributed to the additional production. This analysis takes the estimated increase in income and subtracts the
estimated increase in costs. If the increase in income outweighs the increase in cost, the expansion may be a wise
investment.

For example, consider a hat manufacturer. Each hat produced requires seventy-five kobo (₦0.75) of plastic and
fabric. Your hat factory incurs ₦100 dollars of fixed costs per month. If you make 50 hats per month, then each hat
incurs ₦2 of fixed costs. In this simple example, the total cost per hat, including the plastic and fabric, would be
₦2.75 (₦2.75 = ₦0.75 + (₦100/50)). But, if you cranked up production volume and produced 100 hats per month,
then each hat would incur ₦1 dollar of fixed costs because fixed costs are spread out across units of output. The
total cost per hat would then drop to ₦1.75 (₦1.75 = ₦0.75 + (₦100/100)). In this situation, increasing production
volume causes marginal costs to go down.

2.2.4 Why Is Marginal Analysis Important

Marginal analysis is important because it identifies the most efficient use of resources. An activity should only be
performed until the marginal revenue equals the marginal cost; beyond this point, it will cost more for every unit
that the benefit received for every unit.

2.4 Cash Flows and Cash Flow Diagrams Cash

flows are a fundamental tool in engineering economic analysis. Cash flows represent transactions in which money
changes hands between two or more parties for example lending $10.00 to a friend or making a payment on a car
loan, for example. Representing transactions as cash flows makes it easier to keep track of the important
information included in the transactions. Specifically, there are two characteristics of financial transactions that are
indicated in cash flows:

i) Value – the magnitude of the transaction being described. This is dependent on two factors: the amount of money or
currency changing hands (e.g, a dollar value) and the direction in which the money is flowing (the orientation of the
cash flow). We represent financial gains (also called receipts or income) as positive in value, and financial losses
(also called disbursements or expenses) as negative in value.
ii) Timing – the time or period in which the cash flow occurs. Often, periods are set to coincide with interest periods,
which will be discussed further in the Time Value of Money chapter. Typically, periods are in increments of
months, quarters (1/4 of a year), semi-annual, or annual but other time increments may also be used. Let’s use the
example of someone lending $10.00 to a friend. We’ll assume Riley lends his friend Chris $10.00 on January 1, and
Chris pays back the $10.00 on February 1. There are two transactions in this example: the initial lending on January
1, and the repayment on February 1. Each can be represented by its own cash flow. From Riley’s perspective, as
the lender, the two cash flows would look like so:

Table 2: Cash flows from Riley’s Perspecitve

Cash Flow Timing Value

Lend $10 to Chris January 1 -$10.00

Receive $10 from Chris February 1 +$10.00

The table in Table 2 gives a concise summary of the two cash flows involved in the example, from the lender’s
perspective. But how would things change if we made the same table from Chris’s (the borrower’s) perspective?

Table 3: Cash flows from Chris’ Perspecitve

Cash Flow Timing Value

Receive $10 from Riley January 1 +$10.00

Repay $10 to Riley February 1 -$10.00

As we can see by comparing Tables 2 and 3, changing perspectives changes the signage of the cash flows. This is
because when one party gives money to the other, the recipient’s total assets increase, and the donor’s assets
decrease.

The previous example shows how cash flows can be used to summarize the important information in financial
transactions. When conducting an analysis in a spreadsheet it is common to list cash flows in tabular format. When
trying visualize or explain the financial transactions in a particular analysis, cash flows can be represented in a much
simpler way known as the cash flow diagram. Cash Flow Diagrams are simple graphical representations of
financial transactions. The diagrams consist of arrows, such as in the diagram shown below.
 Figure 1 Cash Flow Diagram

Cash flows like the ones shown in the above figure are typical. There are some basic rules for creating cash flow
diagrams:

i) Time is represented by a horizontal line marked with the number of periods in the analysis. The choice of time
interval will reflect the project or transactions being considered.
ii) The horizontal position of each arrow indicates the timing of that cash flow.
iii) Upward arrows represent positive cash flows, also known as inflows, income, or receipts.
iv) Downward arrows represent negative cash flows, also known as outflows, disbursements, or expenses.
v) Each arrow represents the net cash flow in that period (receipts – disbursements). There is only one cash flow
arrow for each period representing this net value.

Let’s return to the previous example: Riley lending $10.00 to Chris. We can draw out the cash flows graphically as
a cash flow diagram. Just like with the tabular form of the cash flows, we can represent the cash flows in two
different diagrams: one from Riley’s perspective and one from Chris’s perspective. If we set January to be the first
period, and February to be the second period, the two diagrams would look like so:

Figure 2: Cash flow diagrams of a lending agreement

These diagrams are really just graphical representations of financial transactions. As one can see, the diagrams for
Riley and Chris give the same information as the tables we showed before, but it may be less time-consuming to
draw these simple diagrams than it is to write out an entire table. The movement of money is also easier to show
graphically. Note that only one of the diagrams is required to represent the problem. You would simply choose to
display the project from either Riley’s perspective or from Chris’s perspective.

Note that this difference in perspective does not affect the equivalence of cash flows. The different perspectives
affect the signs of the cash flows (i.e. positive or negative), but the net effect remains the same. In this example,
both parties ended up with no net loss or gain after Riley was repaid, because no interest was charged on the loan. If
Riley had charged Chris $1.00 in interest, then Riley would have earned a net profit of $1.00 and Chris would have
lost $1.00 in total. The money is all accounted for, regardless of who the observer is.
2.4.1 End-of-Period Convention

In practice, cash flows can occur at any time within a period. However, for simplicity, we commonly assume
the end-of-period convention – the assumption that all cash flows occurring within a period are moved to the end
of the period. The following figure graphically demonstrates the end-of-period convention.

Fig. 4: End of Period Diagram

In the figure 4, there are several cash flows at different times within the same period. Using the end-of-period
convention, we sum these cash flows together and move them to the end of the interest period as one net cash flow.

While this assumption could introduce some discrepancies between the model and real-world results, it simplifies
calculations greatly.

2.5 Time value of money

The time value of money (TVM) is the concept that a sum of money is worth more now than the same sum will be
at a future date due to its earnings potential in the interim. The time value of money is a core principle of finance. A
sum of money in the hand has greater value than the same sum to be paid in the future. The time value of money is
also referred to as the present discounted value. The time value of money means that a sum of money is worth more
now than the same sum of money in the future. The principle of the time value of money means that it can grow
only through investing so a delayed investment is a lost opportunity.

Understanding the Time Value of Money (TVM)

Investors prefer to receive money today rather than the same amount of money in the future because a sum of
money, once invested, grows over time. For example, money deposited into a savings account earns interest. Over
time, the interest is added to the principal, earning more interest. That's the power of compounding interest. If it is
not invested, the value of the money erodes over time. If you hide $1,000 in a mattress for three years, you will lose
the additional money it could have earned over that time if invested. It will have even less buying power when you
retrieve it because inflation reduces its value.

As another example, say you have the option of receiving $10,000 now or $10,000 two years from now. Despite
the equal face value, $10,000 today has more value and utility than it will two years from now due to the
opportunity costs associated with the delay. In other words, a delayed payment is a missed opportunity.

The time value of money has a negative relationship with inflation. Remember that inflation is an increase in the
prices of goods and services. As such, the value of a single dollar goes down when prices rise, which means you
can't purchase as much as you were able to in the past.
2.5.1 Time Value of Money Formula

The most fundamental formula for the time value of money takes into account the following: the future value of
money, the present value of money, the interest rate, the number of compounding periods per year, and the number
of years.

Based on these variables, the formula for TVM is:

Where:

FV=Future value of money

PV=Present value of money

i=Interest rate

n=Number of compounding periods per year

t=Number of years

Keep in mind, though that the TVM formula may change slightly depending on the situation. For example, in the
case of annuity or perpetuity payments, the generalized formula has additional or fewer factors.

The time value of money doesn't take into account any capital losses that you may incur or any negative interest
rates that may apply. In these cases, you may be able to use negative growth rates to calculate the time value of
money

2.5.2 Examples of Time Value of Money

Here's a hypothetical example to show how the time value of money works. Let's assume a sum of $10,000 is
invested for one year at 10% interest compounded annually. The future value of that money is:

=$11,000

The formula can also be rearranged to find the value of the future sum in present-day dollars. For example, the
present-day dollar amount compounded annually at 7% interest that would be worth $5,000 one year from today
is:

[ ] = $4,673

Effect of Compounding Periods on Future Value

The number of compounding periods has a dramatic effect on the TVM calculations. Taking the $10,000 example
above, if the number of compounding periods is increased to quarterly, monthly, or daily, the ending future value
calculations are:
 (a) Quarterly Compounding: =$11,038
(b) Monthly Compounding: = 11,047
(c) Daily Compounding: FV = $10,000 = $11,052

This shows that the TVM depends not only on the interest rate and time horizon but also on how many times the
compounding calculations are computed each year.

2.5.3 How Does the Time Value of Money Relate to Opportunity Cost?

The opportunity cost of a choice is the value of the best alternative forgone where, given limited resources, a
choice needs to be made between several mutually exclusive alternatives. Hence, opportunity cost is the value of
what you lose when choosing between two or more options. Opportunity cost is key to the concept of the time
value of money. Money can grow only if it is invested over time and earns a positive return. Money that is not
invested loses value over time. Therefore, a sum of money that is expected to be paid in the future, no matter how
confidently it is expected, is losing value in the meantime.

2.5.4 Why Is the Time Value of Money Important

The concept of the time value of money can help guide investment decisions. For instance, suppose an investor can
choose between two projects: Project A and Project B. They are identical except that Project A promises a $1
million cash payout in year one, whereas Project B offers a $1 million cash payout in year five. The payouts are
not equal. The $1 million payout received after one year has a higher present value than the $1 million payout after
five years.

It would be hard to find a single area of finance where the time value of money does not influence the decision-
making process. The time value of money is the central concept in discounted cash flow (DCF) analysis, which is
one of the most popular and influential methods for valuing investment opportunities. It is also an integral part of
financial planning and risk management activities. Pension fund managers, for instance, consider the time value of
money to ensure that their account holders will receive adequate funds in retirement.

2.5.5 What Impact Does Inflation Have on the Time Value of Money

The value of money changes over time and there are several factors that can affect it. Inflation, which is the
general rise in prices of goods and services, has a negative impact on the future value of money. That's because
when prices rise, your money only goes so far. Even a slight increase in prices means that your purchasing power
drops. So that dollar you earned in 2015 and kept in your bank buys less today than it would have back then.

2.5.6 How Do You Calculate the Time Value of Money

The time value of money takes several things into account when calculating the future value of money, including
the present value of money (PV), the number of compounding periods per year (n), the total number of years (t),
and the interest rate (i). You can use the following formula to calculate the time value of money:

FV = PV x [1 + (i / n)] (n x t).
The Bottom Line: The future value of money isn't the same as present-day dollars. And the same is true about
money from the past. This phenomenon is known as the time value of money. Businesses can use it to gauge the
potential for future projects. And as an investor, you can use it to pinpoint investment opportunities. Put simply,
knowing what TVM is and how to calculate it can help you make sound decisions about how you spend, save, and
invest money .

2.5.6 Simple Interest

Simple Interest (S.I.) is the method of calculating the interest amount for a particular principal amount of money at
some rate of interest. Interest is the cost of borrowing money. Typically expressed as a percentage, it amounts to a
fee or charge that the borrower pays the lender for the financed sum.

Its formula: SI = (PRT) / 100

A = P (1 + RT)

A = final amount

P = initial principal balance

R = annual interest rate

T = time (in years)

For example, when a person takes a loan of #5000, at a rate of 10 p.a. for two years, the person's interest for two
years will be S.I. on the borrowed money.

2.5.7 Compound interest

Compound interest is the interest calculated on the principal and the interest accumulated over the previous period.

2.5.9 Compound Interest Formula

The compound interest is the interest-based on the initial principal amount and the interest collected over the period
of time. The compound interest formula is given below:

Compound Interest = Amount – Principal

Here, the amount is given by

Where,

 A = amount
 P = principal
  r = rate of interest
 n = number of times interest is compounded per year
 t = time (in years)
Alternatively, we can write the formula as given below:

CI = A – P

And

This formula is also called periodic compounding formula.

 A represents the new principal sum or the total amount of money after compounding period
 P represents the original amount or initial amount
 r is the annual interest rate
 n represents the compounding frequency or the number of times interest is compounded in a year
 t represents the number of years
It is to be noted that the above formula is the general formula for the number of times the principal is compounded
in a year. If the interest is compounded annually, the amount is given as:

Thus, the compound interest rate formula can be expressed for different scenarios such as the interest rate is
compounded yearly, half-yearly, quarterly, monthly, daily, etc.

NOTE: From the data, it is clear that the interest rate for the first year in compound interest is the same as that in
simple interest. PRT/100. Other than the first year, the interest compounded annually is always greater than that in
simple interest.

2.5.9 Formula for Periodic Compounding Rate

The total accumulated value, including the principal P plus compounded interest I, is given by the formula:

P’ = P[1 + (r/n)]nt

Here,

P = Principal

P’ = New principal

r = Nominal annual interest rate

n = Number of times the interest is compounding

t = Time (in years)

In this case, compound interest is:

CI = P’ – P
CI = P[1 + (r/n)]nt -P
How to Calculate Compound Interest?
Let us understand the process of calculating compound interest with the help of the below example.

Example: What amount is to be repaid on a loan of Rs. 12000 for one and half years at 10% per annum
compounded half yearly?

Solution:

For the given situation, we can calculate the compound interest and total amount to be repaid on a loan in two ways.
In the first method, we can directly substitute the values in the formula. In the second method, compound interest
can be obtained by splitting the given time bound into equal periods.

This can be well understood with the help of the table given below.

Compound Interest Solved Examples

As mentioned above, compound interest has many applications in real-life. Let us solve various examples based on
these applications to understand the concept in a better manner.

Increase or Decrease in Population

Examples 1: A town had 10,000 residents in 2000. Its population declines at a rate of 10% per annum. What will be
its total population in 2005?

Solution: The population of the town decreases by 10% every year. Thus, it has a new population every year. So the
population for the next year is calculated on the current year population. For the decrease, we have the formula A =
P(1 – R/100)n
Therefore, the population at the end of 5 years = 10000(1 – 10/100)5
= 10000(1 – 0.1)5 = 10000 x 0.95 = 5904 (Approx.)

Examples 2: The count of a certain breed of bacteria was found to increase at the rate of 2% per hour. Find the
bacteria at the end of 2 hours if the count was initially 600000.

Solution: Since the population of bacteria increases at the rate of 2% per hour, we use the formula
A = P(1 + R/100)n
Thus, the population at the end of 2 hours = 600000(1 + 2/100)2
= 600000(1 + 0.02)2 = 600000(1.02)2 = 624240

Examples 3: The price of a radio is Rs. 1400 and it depreciates by 8% per month. Find its value after 3 months.

Solution: For the depreciation, we have the formula A = P(1 – R/100)n.

Thus, the price of the radio after 3 months = 1400(1 – 8/100)3
= 1400(1 – 0.08)3 = 1400(0.92)3 = Rs. 1090 (Approx.)

2.5.10 Compound Interest and Simple Interest

Now, let us understand the difference between the amount earned through compound interest and simple interest on
a certain amount of money, say Rs. 100 in 3 years . and the rate of interest is 10% p.a.

Below table shows the process of calculating interest and total amount.

2.5.11 Compound Interest Problems

Try solving the below questions on compound interest.

1. A sum of Rs.10000 is borrowed by Akshit for 2 years at an interest of 10% compounded annually. Find the
compound interest and amount he has to pay at the end of 2 years.

2. What is the compound interest (CI) on Rs.5000 for 2 years at 10% per annum compounded annually?

3. What is the compound interest to be paid on a loan of Rs.2000 for 3/2 years at 10% per annum compounded
half-yearly?
4. What is the least number of complete years in which a sum of money put out at 20% compound interest will be
more than doubled?

5. Heera invests Rs. 20,000 at the beginning of every year in a bank and earns 10 % annual interest, compounded
at the end of the year. What will be her balance in the bank at the end of three years?

6. What is the difference between the compound interests on Rs. 5000 for one and half years at 4% per annum
compounded yearly and half-yearly?

2.5.12 Questions and Answers on Compound Interest

Q1.What is Compound interest?

Compound interest is the interest calculated on the principal and the interest accumulated over the previous period.

Q2, How do you calculate compound interest?

Compound interest is calculated by multiplying the initial principal amount (P) by one plus the annual interest rate
(R) raised to the number of compound periods (nt) minus one. That means, CI = P[(1 + R)nt – 1] Here,
P = Initial amount
R = Annual rate of interest as a percentage
n = Number of compounding periods in a given time

Q3 Who benefits from compound interest?

The investors benefit from the compound interest since the interest pair here on the principle plus on the interest
which they already earned.

Q4. What is interest compounded quarterly formula?

The formula for interest compounded quarterly is given by:

A = P(1 + (R/4)/100)4T

Q5. How do you find the compound interest rate?

The compound interest rate can be found using the formula,

A = P(1 + r/n){nt}
A = Total amount
P = Principal
r = Annual nominal interest rate as a decimal
n = Number of compounding periods
t = Time (in years)
Thus, compound interest (CI) = A – P

Q6. What is the formula of compound interest with an example?

The compound interest formula is given below:

Compound Interest = Amount – Principal
Where the amount is given by:
A = P(1 + r/n){nt}
P = Principal
r = Annual nominal interest rate as a decimal
n = Number of compounding periods
t = Time (in years)
For example, If Mohan deposits Rs. 4000 into an account paying 6% annual interest compounded quarterly, and
then the money will be in his account after five years can be calculated as:
Substituting, P = 4000, r = 0.06, n = 4, and t = 5 in A = A = P(1 + r/n){nt}, we get A = Rs. 5387.42

Q7. What is the compounded daily formula? The compound interest formula when the interest is compounded daily
is given by:
A = P(1 + r/365){365 * t}

2.5.13 Difference between Simple and Compound Interest

Simple Interest: Simple interest can be defined as the principal amount of a loan or deposit a person makes into their
bank account.

Compound Interest: Compound interest is the interest that accumulates and compounds over the principal amount.

Below you can find the key differences between Simple Interest and Compound Interest in the tabular column
below:

Simple Interest and Compound Interest Differences

Parameter Simple Interest Compound Interest

Definition Simple Interest can be defined as the Compound Interest can be defined as when the sum
sum paid back for using the borrowed principal amount exceeds the due date for payment,
money over a fixed period of time. along with the rate of interest for a period of time.

Formula S.I. = (P × T × R) ⁄ 100 C.I. = P(1+R⁄100)t − P

Return The return is much lesser when The return is much higher.
Amount compared to compound interest.

Principal The principal amount is constant. The principal amount keeps on varying during the
Amount entire borrowing period.

Growth The growth remains quite uniform in The growth increases quite rapidly in this method.
this method.

Interest The interest charged on is for the The interest charged on it is for the principal and
Charged principal amount. accumulated interest.

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Solved Examples
Q.1: Olumide borrowed ₦50,000 for 3 years at a rate of 3.5% per annum. Find the simple interest.
Solution: Given,
P = ₦ 50,000
R = 3.5%
T = 3 years
SI = (P × R ×T) / 100
SI = (50,000× 3.5 ×3) / 100 = 5250

Q.2: The count of a population of men was found to increase at the rate of 2% per hour. Find the count at the end of
2 hours if the initial count was 600000.
Solution: Since the population of men increases at the rate of 2% per hour, we use the formula
A = P(1 + R/100)n
Thus, the population at the end of 2 hours = 600000(1 + 2/100)2
= 600000(1 + 0.02)2
= 600000(1.02)2
= 624240

Q3 What is the main difference between simple interest and compound interest?

Simple interest is computed on the principal amount or loan amount whereas compound interest is computed based
on the principal amount as well as the interest accumulated for a certain period or previous period.

Q4 What is the formula for simple interest?

The formula for simple interest is given by:

SI = (P x R x T)/100
where SI = Simple Interest
P = Principal Amount
R = Rate of interest
T = Time duration in years

Q5 What is the formula for compound interest?

The formula for compound interest is given by:

CI = Amount – Principal
and Amount = P(1+r/n)nt

Q6 What is the formula for the amount if it is compounded annually?

If the amount is compounded annually, the amount is given as:

A = P(1+R/100)t