Department of Business and Economics Western University

Compound Interest
CHAPTER
4

ESSENTIAL NOTES

1 A principal sum earns interest at the end of one interest period.

2 The interest earned is added to the principal sum at end of the interest
period.

3 Hence, which compound interest the principal does not remain fixed. It
is cumulative in the sense that interest at the end of one period is added
to the principal of the same period. The accumulated amount becomes
the “new” principal for the next interest period.

 DEFINITIONS USED

Definition Explanation
- sum of money saved, borrowed or invest
- it is known as the present value of the accumulated
Principal amount
- It is also called the discounted value of the
accumulated amount

Accumulated - the sum total of interest earned and the principal

Amount - it is the compound amount of the principal

- the accumulated amount minus the principal

Compound
- it is the difference between the accumulated amount
Interest
and the principal

Nominal Rate
- interest compound more than a year
of Interest
Effective Rate - interest compounded once a year
of Interest - the interest rate actually earned in one year

Page 1 of 13 CHEA Sopheap, MBA

Department of Business and Economics Western University

 NOTATIONS USED

P means Principal sum or the present value or the

discounted value of the accumulated amount
S means Accumulated amount
i means Rate of interest per interest period
n means Number of interest period

 IMPORTANT FORMULAE AND HOW WE ARRIVE AT

THE VARIOUS FORMULAE

The table below shows the various steps of obtaining the formula of the
accumulated amount S, assuming that the rate of interest per interest period is
constant for each interest period.

End of
Rate of Interest Accumulated Amount
Interest Principal
interest due Principal + Compound Interest
period
1 P r Pr P + Pi = P (1+i)1

2 P (1+i)1 r P (1+i)1 i P (1+i)1 + P (1+i) i = P (1+i) (1+i) = P (1+i)2

3 P (1+i)2 r P (1+i)2 i P (1+i)2 + P (1+i)2 i = P (1+i)2 (1+i) = P (1+i)3

4 P (1+i)3 r P (1+i)3 i P (1+i)3 + P (1+i)3 i = P (1+i)3 (1+i) = P (1+i)4

5 P (1+i)4 r P (1+i)4 i P (1+i)4 + P (1+i)4 i = P (1+i)4 (1+i) = P (1+i)5

-
- - - - -
-
- - - - -
-
n P (1+i)n r P (1+i)n-1 i P (1+i)n-1 + P (1+i)n-1 i = P (1+i)n-1 (1+i)

= P (1+i)n

Hence, the accumulated amount, S, for n interest periods at a constant rate of

interest i per interest period is giving as:

S = P (1 + i) n

Consequently, for compound interest at a nominal rate, the accumulate

amount S, is calculated at a constant rate of interest i per period for n years.

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Department of Business and Economics Western University

 COMPOUND INTEREST AND SIMPLE INTEREST

Comparison of Compound Interest and Simple Interest

Simple Interest Compound Interest

P = $100 r = 10% p.a P = $100 i = 10% p.a

Yr 1 S = P (1 + rt) Yr 1 S = P (1 + i) n
= $100 (1 + 0.1 x 0.10) = $100 (1 +0.10) 1
= $110 = $110

Interest = $110 - $100 Interest = $110 - $100

= $10 = $10

Simple Interest Compound Interest

Yr 2 S = P (1 + rt) Yr 2 S = P (1 + i) n
= $100 (1 + 0.1 x 0.10) = $110 (1 +0.10) 1
= $110 = $121

Interest = $110 - $100 Interest = $121 - $110

= $10 = $11

Simple Interest Compound Interest

Yr 3 S = P (1 + rt) Yr 3 S = P (1 + i) n
= $100 (1 + 0.1 x 0.10) = $121 (1 +0.10) 1
= $110 = $133.10

Interest = $110 - $100 Interest = $133.10 - $110

= $10 = $12.10

4 Formula for Simple Interest

I = P.r.t

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Department of Business and Economics Western University

WORKED EXAMPLES

QUESTION 1
A man applies for a loan of $5,000 from a bank which charges
simple interest at 12% per annum. Find the exact simple interest
charged if the man borrows the money for (a) 3 years, (b) 9
months, (c) 150 days.

 SOLUTION

P = $5,000 r = 12% p.a I = Simple interest

(a) I = P.r.t
= $5,000 x 0.12 x 3
= $1,800

(b) I = P.r.t / 12
= $5,000 x 0.12 x 9 / 12
= $450

(c) I = P.r.t / 12
= $5,000 x 0.12 x 150 / 365
= $246.58

QUESTION 2
Find the ordinary simple interest of a loan of $6,500 at 15% p.a
for (a) 2 years, (b) 4 months, (c) 200 days.

 SOLUTION

P = $6,500 r = 15% p.a I = Simple interest

(a) I = P.r.t
= $6,500 x 0.15 x 2
= $1,950

(b) I = P.r.t / 12
= $6,500 x 0.15 x 11 / 12
= $325

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Department of Business and Economics Western University

(c) I = P.r.t / 360

= $6,500 x 0.15 x 200 / 360
= $541.67

10 Formula for Accumulated amount

S = P+I
= P + P.r.t
or S = P (1 + r.t)

S = P (1+r.t)

WORKED EXAMPLES

QUESTION 3
A man invested $20,000 in a business project that earned simple
interest at a rate of 15% p.a for 3 years. Find the amount of
investment at the end of 3 years.

 SOLUTION

P = $20,000 r = 15% p.a t = 3 years

S = total investment at the end of 3 years

S = P (1 + 0.15 x 3)
= $20,000 (1 + 0.15 x 3) = $29,000

QUESTION 4
A bank paid simple interest at a rate of 9 ½ p.a. A man deposited
a sum of $12,000 on March 10, 2004 in the bank. Find the
accumulated amount on September 15, 2004.

 SOLUTION

P = $12,000 r = 9 1/2 % p.a t = days

S = accumulated amount on September 15, 2004

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Department of Business and Economics Western University

Months Number of days

March 21
April 30
May 31
June 30
July 31
August 31
September 15
Total 189

S = P (1 + r.t)
= $12,000 (1 + 0.095 x 189 / 365 )
= $12,590.30

11 Formula for Time

I
t = -------
P.r

WORKED EXAMPLES

QUESTION 5
How long will it take a sum of $3,200 to amount to $1,500 at a
simple interest rate of 10% p.a.?

 SOLUTION

P = $3,200 r = 10% p.a t = years

Since I=S–P
I = $3,200 - $1,500
= $1,700

I
and t = --------
P.r

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Department of Business and Economics Western University

1,700
t = --------------------- = 11.33 years
1,500 x 0.10

QUESTION 6
How long will it take a sum of $2,000 to amount to $4,500 at a
simple interest of 10% p.a ? (Months?)

 SOLUTION

P = $2,000 r = 12% p.a S = $4,500 t = months

Since I=S–P
I = $4,500 - $2,000
= $2,500

I
and t = --------
P.r

2,500
t = --------------------- = 12.50 years = 150 ms
2,000 x 0.10

12 Formula for Principal

S = P (1 + r.t)

S
==> P = ----------------
(1 + r.t)

0r P = S (1 + r.t) -1

S
P = ------------ or P = S (1 + r.t) -1
(1 + r.t)

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Department of Business and Economics Western University

WORKED EXAMPLES

QUESTION 7
A sum of money invested today will amount to $2,500 in 10
months at simple interest rate of 10 ¼ % p.a. Find the sum of
money invested.

 SOLUTION

P = the sum of money invested r = 10 ¼ % p.a

t = 10 months S = $2,500

Since S = P (1 + r.t)
‫א‬ P = S (1 + r.t) -1
= $2,500 (1 + 0.1025 x 10 / 12) –1
= $2,303.26

QUESTION 8
A sum of money invested on February 27, 2004 will amount to
$3,000 on August 18, 2004 at simple interest rate of 11% p.a.
Find the sum of money invested.

 SOLUTION

P = the sum of money invested r = 11% p.a

t = 172 days S = $3,000

Since S = P (1 + r.t)
‫א‬ P = S (1 + r.t) -1
= $3,000 (1 + 0.11 x 172 / 365) –1
= $2,852.16

13 Formula for Interest Rate

I
r = --------
r.t

WORKED EXAMPLES
Page 8 of 13 CHEA Sopheap, MBA
Department of Business and Economics Western University

QUESTION 9
Calculate the rate of simple interest that will give $8,000 interest
on a principle of $20,000 at the end of 4 ½ years.

 SOLUTION

P = $20,000 r = rate of simple interest

½
t = 4 yearsI = $8,000

Since I = P.r.t
I
r = ------
P.t
8,000
= -------------------
20,000 x 4.5

= 0.8888 = 8.89%

QUESTION 10
On January 12, 2004 a man invested a sum of $3,500. On
October 20, the investment had amounted to $4,000. Find the
rate of simple interest, using exact simple interest and exact time
for your calculations.

 SOLUTION

Months Number of Days

January 19
February 29 (leap year)
March 31
April 30
May 31
June 30
July 31
August 31
September 30
October 30
Total 282

P = $3,500 S = $4,000 t = 282 days

Page 9 of 13 CHEA Sopheap, MBA
Department of Business and Economics Western University

r = rate of simple interest

I = S–P
= $4,000 - $3,500
= $500
I
and r = ------
P.t
500
= -----------------------
3,500 x 282 / 366

= 0.1854 = 18.54%

14 Saving Account or Saving Deposit

ESSENTIAL NOTES

If Deposit on 01 to 15 ==> Maturity Date 16

16 to 31 ==> 01 next month

If Withdrawal on 01 to 15 ==> Maturity Date 01

16 to 31 ==> Maturity Date 16

WORKED EXAMPLES

QUESTION 11

A man has a saving account in your bank and the he made the
transaction as belong:
(a) 13-02-2004 Deposit $100,000
(b) 30-05-2004 Deposit $150,000
(c) 10-07-2004 Withdrawal $10,000
(d) 01-08-2004 Deposit $50,000
(e) 20-09-2004 Withdrawal $100,000
(f) 25-10-2004 Withdrawal $10,000
Calculate his balance on 01 January 2005 which include interest
rate 4% p.a.

 SOLUTION

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Department of Business and Economics Western University

QUESTION 12

A man has a saving account in your bank and the he made the
transaction as belong:
(a) 16-03-2004 Deposit $600,000
(b) 01-04-2004 Deposit $350,000
(c) 16-06-2004 Withdrawal $30,000
(d) 16-08-2004 Deposit $40,000
(e) 01-10-2004 Withdrawal $600,000
(f) 16-11-2004 Withdrawal $20,000
Calculate his balance on 01 January 2005 which include interest
rate 3% p.a.

 SOLUTION

WORKED EXAMPLES
Page 11 of 13 CHEA Sopheap, MBA
Department of Business and Economics Western University

1- A man wishes to buy goods worth $5000. He will be given a

cash discount of 4% if paid within 10 days. However, if he pays
within 30 days, he will be charged full-amount. Calculate the
highest rate of simple interest acceptable to the man in order for
him to obtain a loan for the cash payment taking the advantage of
the cash discount offered.
2- A man wishes to buy a price of property costing $150,000. He
has to pay 20% down payment and the rest borrowed from a
finance company which charges simple interest at a rate of 11 ¾
percent per annual. If he decide to borrow the sum for 10 years,
find (a) the annual interest charged, (b) the total amount of
interest charged for 10 years, (c) the accumulated amount of the
loan at the end of 10 years.
3- A man bought a present worth $6,000 on the 5th of January. He
used his credit card to pay for the present. The credit card
company charged simple interest at a rate of 10.50% on the
balance outstanding. The man made the following payments
scheme:

Dates Payments Made

28 January $2,000
12 February $1,000
25 March $1,500
6 April $1,500

Calculate the total interest charged by the credit card company

(Assuming February has 28 days)
4- A man borrows from a bank for a sum of $6,500. If the bank
charges simple interest at 12% per annum, find the exact simple
interest payable for (a) 2 ½ years, (b) 18 months and (c) 210 days.
5- A bank pays simple interest at 15% per annum. A sum of $5,000
is deposited in the bank. Find the ordinary simple interest earned,
if the sum is deposited for (a) 3 years, (b) 15 months and (c) 450
days.
6- A sum of $12,500 is invested in a managed fund that earns
interest at a rate of 8¾ % per year. How long will it take for the
sum to amount to $20,000?
7- On January 15, 2004 a man invested $50,000 in a mutual fund
that paid simple interest at 10½ % per annum. Find the date in
which the investment would accumulate to $65,000.
8- A man deposits a sum of $12,000 in a bank that pays simple
interest at a rate of 7 ¾ % per annum. Find the accumulated
amount at the end of (a) 4 years, (b) 10 months and (c) 250 days,
using ordinary simple interest for your calculation.
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Department of Business and Economics Western University

9- On March 02, 2004 a sum of $15,000 was invested in unit trust

that earned simple interest at 8 ¼ % per annum. Find the
accumulated amount of the investment on August 2004 using
ordinary simple interest and approximate time for year
calculations.
10- An accountant calculated that in 4 years’ time a sum of money
would amount to $4,500 at a simple interest rate of 12% per year.
Find the present value of the of money.
11- A man estimates that at a simple interest rate of 15% per annum,
a sum of money invested today will amount to $15,500 in 450
days. Find the sum of money invested using exact simple interest
for your calculations.
12- On February 5, 2004 a man invested a sum of money in a
business project that paid simple interest at a rate of 15% per
annum. On April 10, 2004 the total investment had amounted to
$50,000. Find the sum of the original investment.
13- A sum of $6,000 invested today will accumulate to $10,000 in 5
year. Find the simple interest rate.
14- On August 25, 2004 a sum of $12,000 invested earned simple
interest and on April 30, 2004 the investment had amounted to
$15,000. Find the rate of simple interest.
15- A loan of $50,000 is taken from a bank which charges 8 ¾ %
simple interest on the outstanding balance. Calculated the total
interest charged if the loan is taken on July 6 and the following
payment scheme made.

Dates Payment Made

30 July $5,000
15 August $25,000
10 October $15,000
5 December $5,000

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