(Simple and Compound

Interests)
OBJECTIVES
• Illustrates simple and compound interests.
• Distinguishes between simple and compound interests
• Computes interest, maturity value, future value and present
value in simple interests and compound interest
environment
• Solves problems involving simple and compound interests.
PRE-TEST
“ Money makes money, and the money that money makes, makes more money.”
- Benjamin Franklin
“While money doesn’t grow on trees, it can grow when you save and invest wisely.”
_ U.S. Security and Exchange Commission
Solve the following problems.

1. In order to buy a new gadget, Maria decided to borrow P5,000 at annual simple
interest rate of 5%. After two years, how much interest does she has to pay?
2. As preparation for Victor’s college studies, his parents want to save an amount of
P200,000 after 3 years. If they decided to deposit in a bank offering an
annual simple interest rate of2.5%, how much do they need to deposit now?
 
Individuals, whether engaged in business or not, occasionally find
themselves in need of money/funds for worthwhile purposes. One
recourse they usually resort to borrowing. On the other hand, a
business or person who has excess money may want to invest this
through lending. The one who invest the money is the lender or
creditor and the one who owes it, is the borrower or debtor.
The lender , of course expects a sum in addition to what he has
lent; this is actually the interest—the income he has earned.
However, on the part of the borrower, this interest is his cost for
the use of the money. Simply stated, interest is money paid for
the use of money. Interest may be computed by either of the
two most common methods simple or compound.
 Definition: Simple Interest

Simple interest is an interest computed on the amount the

borrower/depositor received at the time the loan/ deposit is obtained
and is added to the amount when the loan /deposit becomes due.
Simple interest
simple interest is I = PRT, where
generally used in short I = Interest
term transactions, most P = Principal
often of duration less
R = interest rate (written as decimal)
than one year.
T = time (in years)
  
Example 1: The principal is the amount of deposit
Monica borrowed P280,000 at a simple made by a depositor or the face amount
lent to the borrower on loan date. In
interest rate of 9% for one year. Compute for
the illustration, the principal is
the simple interest and maturity value of the P280,000. The simple interest rate
loan. expressed as a percentage, is converted
  Finding the simple interest to a decimal for computation purposes.
Solution; In the example, the rate is 9% or in
Interest = Principal x Rate x Time decimal form, 0.09.
The time is the length of time for
I = P280,000 x 0.09 x 1 which the money is borrowed or lent.
I = P25,200 The time expressed in years or
Thus, a loan of P280,000 for one year at fractional part of a year is the period
between the loan date the date when
simple interest rate of 9% will cost Monica the loan becomes due. In the example
P25,200 in interest. the time is one year
 Finding the maturity value
Solution:
After one year, Monica’s loan
matures and she obliged to pay The maturity value is solved as,
Maturity Value = Principal + Interest
the maturity value of the loan. MV = P280,000 + P25,200
This is the sum of the principal MV = P305,200
Hence, on maturity date, in
she received on loan date and the
addition to principal of P280,000
interest. In formula, that Monica received when she
obtained the loan, she is to pay
Maturity Value = Principal + Interest P25,200 in interest; or a total of
P305,200.
MV = P + I  
 
The concept of time
The time T in the simple interest formula I = PRT is the period between the loan
date and the maturity date. In the previous example, time is exactly one year. With the
simple interest rate expressed as an annual rate with the time expressed in years, the
computation of the interest and maturity value in the example is as simple as just getting
the product of the principal, rate and time.
If the time in years is not exact, say 1 year and six months or 1 years, it has to be
converted to decimals hence it becomes 1.5 years, 2 years and 3 months or 2 years
becomes 2.25; and 3 years and 9 months or 3 years becomes 3.75 years. This, of course,
is being done to facilitate the computation.
 In other cases, the time T may be given in months. Be it more
than 12 months or less, the 12-month period is used in
converting time into a fraction form. Again, since the simple
interest rate is given as an annual rate, the time should be
prorated accordingly. It is also advisable to convert the time in
months to decimal form. By doing this, the time in months is
actually converted in terms of years. However, in instances
when it would be impracticable to convert the number of
months to decimal form, say 7 months or 7/12, the fractional
form may be substituted to the simple interest formula as is.
 If the time T is given in months and only the loan
date is stated , the maturity date shall coincide with the
loan date. Thus, a loan is obtained on June 13, 2020
payable in 4 months will mature October 13,2020.

In addition, if either the loan date or maturity date

does not make mention of the year, it shall be assumed
that these date fall on the same year. For example, a
loan that was granted on March 7, 2020 and to mature
on October 12 would mature on October 12, 2020.
 There are also cases when the time T is stated as a
certain number of days. It follows that the year should
likewise be measured in terms of the number of days.
Two methods are at hand:
the exact interest method, which uses 365 days as the
time denominator;
the ordinary interest method, which uses 360 days.

Note that the exact interest method uses 366 days in a leap year .
Example 2:
If Michael borrowed P140,000 at 7% interest for 64 days,
how much would the interest using the exact and ordinary
interest methods?
Solution:
Exact interest method: I = Principal x Rate x Time
I = 140,000 x 0.07 x 64/365
I = P1,718.36
 Ordinary interest method: I = Principal x Rate x Time
I = 140,000 x 0.07 x 64/360
I = P1,742.22
Noted that the ordinary interest method yielded a higher interest.
 When only the loan date and maturity date are
given, the number of days may be counted as either
actual time or approximate time.

Actual time is determined by counting every day

excluding the loan date until the maturity date
while
Approximate time by assuming that each month
has 30 days.
Example 3:

Count the actual time and approximate time from

April 8, 2020 to Sept. 20, 2020.
 Actual time Approximate time
April (30 – 8) 22 April (30-8) 22
May 31 May 30
June 30 June 30
July 31 July 30
August 31 August 30
September 20 September 20
 
Definition: Compound Interest
The compound interest on P is the amount of interest charged to the amount
P and the interest earned on previous time periods.

The future value of P borrowed(or invested) at an annual compound interest rate r at

time t is given by
A(t) = P.

Amount of compound interest

The compound interest on P borrowed(or invested) at annual compound interest rate at time
t is A – P = P[ ].
Example 4.
 
Five years ago, Anna put her savings worth P10,000 in
an account providing a compound interest rate of 3.5%
annually. Find the value of her savings today and the
amount of interest.
S Given: P = P10,000, r = 0.035, and t = 5
O
L A(t) = P
U
T A(5) = 10,000
I
O = P11,876.86
N
The value of Anna’s savings today is P11,876.86
The amount of interest earned is P11,876.86 - P10,000 = P1,876.86.
Example 5.

Find the future value of each of the following at a given

annual rate compounded annually and the given time:

Given Solution: A(t) = P

a. P1,000,at 2% after 3 years A(3) = P
=P1,061.21
b. P2,500 at 2.75% after 5 years A(5) = P
=P2,863.18
c. P10,000 at 1% after 4 years A(4) = P
= P10,406.04
 Compounding periods
Compound interest is interest earned on interest. Unlike in the simple interest where
the interest is taken from the original principal all throughout the transaction period, in the
compound interest, the rate of interest is taken from the accumulated amount(principal for
the period plus the interest of the period or term). Hence, in the compound interest, the
principal amount varies from term to term.
It may be calculated using the compound interest formula:
 
A=P
Where A = amount (future value) If :
c=1(annually)
P = principal (present value) c= 2 (semi-annually)
r = rate c= 4(quarterly)
c = number of compounding c= 12(monthly)
c= 365(daily)
t = time
 Example 6:
Find the future value of P2,000 after one year at 3% interest rate
compounded.  
Quarterly
A = P2,000 = P2,000 = P2.060.68

   
A= P
Monthly
A = P2,000= P2,000 = P2,060.83

 
Daily
A = P2,000 P2,000 = P2.060.91
 
Example 7:
To have a capital for a small food business, Mang Nestor borrowed
P10,000 at 2% interest rate compounded quarterly. How much does Mang
Nestor need to pay after 2 years?
Solution:
Given P= P10,000, r = 0.02, t = 2, and c = 4
A=P
A = 10,000
A = 10,000
A = 10,407.07
Therefore, Mang Nestor needs to pay P10,407.07 after 2 years.
 PRACTICE

Compound Interest versus Simple Interest

Suppose you have P10,000. Divide the amount equally into two parts
and deposit each part in two different accounts---one account provides
3% annual simple interest rate, while the other provides 3% annual
compound rate.

a. Express the future value of each account as a function of time

b. Solve for the future value for t = 1, 2, 3, and 4
c. Sketch the graphs of the function of the future value in one plane
d. Find the total value of your investments in two accounts after 4 years.
  
a. You have your money in two accounts:
• Account 1: P5,000 at 3% annual simple interest rate
A(t) = 5,000(1 + 0.03t) = 5,000 +150t
• Account 2: P5,000 at 3% annual compound interest rate
A(t) = 5,000

b. Using the future values in 1, you can summarize the value of A in the table below.

t Account 1 Account 2
1 5,150.00 5,150.00
2 5,300.00 5,304.50
3 5,450.00 5,463.64
4 5,600.00 5,627.54
c. In A-versus-t plane, the graph of the future values in two accounts is given below.
The dashed line represents the future value in Account 1 while the solid curve represents
that in Account 2

d. The total amount of the

investment in two accounts after 4
years is

P5,600.00 + P5,627.54 = P11,227.54.

 Bear in Mind
The future value under compound interest is an
exponential function of t.

The amount of compound interest earned per unit of time increase as time
increases.

Before borrowing or lending money, it is important that you also consider

the interest cited in the agreement.
I. Solve each of the following problems.
a. How much interest is earned when an amount 0f P100,000 is
invested with an annual interest rate of 8% for 5 years?
Solution:
I=? P = 100,000 R = 8% T = 5 years
I = PRT
I = 100,000(0.08)(5)
I = P40,000
The principal amount of P100,000 will earn a simple interest of
P40,000 for 5 years.
b. How much amount will the investor in problem a
received in 5 years?
Solution:
Using the formula for Future Value/Maturity Value
FV = P + I or FV = P(1 + RT)
FV = 100,000 + 40,000 FV = P140,000
The investor will receive an amount of
P140,000 after 5 years.
 
c. A businessman invested P80,000 in a firm which will earn
an annual simple interest of 12% for 2 years. But financial
needs arise and he has to take them out in 9 months. How
much amount will he receive?
Solution:
P = 80,000 R = 12% or 0.12 T=
Using formula for future value
FV = P(1 + RT)
= 80,000 ( 1 + 0.12(0.75))
= 80,000( 1 + 0.09) = 80,000 (1.09) FV = 87,200
At the end of 9 months, the investor will receive an amount of P87,200.
d. For 5 years, Rio was able to save P350,000 in her savings account. She
invested 40% of it in a catering business with a friend and is earning a
monthly income of 2.5%. Her earnings from the investment go directly to her
savings. How much will her savings be in two years?
Solution: 40% of P350,000 = 140,000 which is the principal amount
2.5% or 0.025 = rate of interest;
I = 12 x 0.025 = 0.3 R = 30% 0r 0.03 T = 2 years
I = PRT
The remaining savings after getting her
I = 140,000 (0.3)(2)
investment of P140,000 is P210,000.
I = P84,000 Adding this up to her earnings of P84,000
in two years from the investment. Rio has
a total savings of P294,000 in two years.