Science, Technology, Engineering and Mathematics

General Mathematics
SY 2020 – 2021

Unit II: Business Mathematics

Lesson #2: Compound Interest

Introduction
Read and analyze the problem below:

Henry borrowed Php 5,000 from Sander. They both

agreed that Henry must repay the amount plus the
interest of 12% a year at the end of 2 years. Also, the
principal will earn interest quarterly at the given rate
divided into periods. This accumulated amount will be the
principal amount for the next period. How much should
Henry pay Sander at the end of the term?

Is it possible to answer this problem using the concept of simple interest? Why? Why not?

In any business establishment, it is a fundamental principle to pay an interest when it is due so that the
interest will be used to earn more money. When earning is added to the principal at regular intervals and
the sum becomes the new principal, the interest is said to be compounded. The present value of the money
is the amount deposited in the current account in order to have a certain target amount in the future.

In the previous lesson, we have discussed the basic concepts of simple interest, its formula, and the
application of it in solving real-life problems. In this module, we will discuss and go deeper to the concept
and complexities of another type of interest which is the compound interest. We will learn how to use its
formula in solving different unknown values and we will apply it in solving different problems.

Learning Objectives
After studying this module with 80% to 100% accuracy, you should be able to:
a) differentiate the concepts of simple and compound interest by giving examples;
b) solve for unknown quantities using the compound interest formula in different problems;
c) perform the step-by-step process of solving compound interest problems using GRESA; and
d) elicit active participation in classroom discussion and activities.

Pre-requisite Skills / Review

Before we proceed directly to the lesson, let us have first a quick refresher on evaluating exponential and
logarithmic expressions. Later, as we progress in our lesson, we will understand the essence of these
concepts in solving for unknown values.

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A. 1. (1 + 0.05)12 B. 1. log 4

2. (2.05)7 2. log100

1 1
3. log
 1 2 2
3.  
4
4. log1000
0.25
 3
4. 1 + 
 4 3
5. log
4
5.

Lesson 2.1 – Concept of Compound Interest

What is Compound Interest?

Compound interest means that the interest is calculated more than once during the time period of the
loan. When compound interest is applied to a loan, each succeeding time period accumulates interest on
the previous interest in addition to interest on the principal. Compound interest loans are generally for
time periods of a year or longer. To easily grasp the difference between compound and simple interest,
refer to the table below:

Compound vs Simple Interest

Simple interest Compound interest
Based on original principal principal that grows from 1
interest interval to another
Function Linear Exponential

Learning Activity

Work with a partner. Let us review that an interest calculated only on principal is called simple
interest. Interest that is calculated on principal and previously earned interest is compound interest.
Suppose you and your partner deposit P 10,000 in a savings account that earns 8% interest per year.

a. Copy and complete the first table that shows the balance after 5 years with simple interest.
b. Copy and complete the second table that shows the balance after 5 years with interest that
is compounded annually.
c. Which type of interest gives the greater balance?

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Simple Interest Compound Interest

Balance at Balance at
Annual Annual
t Principal the end of t Principal the end of
Interest Interest
the year the year
1 1
2 2
3 3
4 4
5 5

Lesson 2.2 – Compounded Annually

Earlier, this problem was presented:

Henry borrowed Php 5,000 from Sander. They both agreed that Henry must repay the
amount plus the interest of 12% a year at the end of 2 years. Also, the principal will earn
interest quarterly at the given rate divided into periods. This accumulated amount will be
the principal amount for the next period. How much should Henry pay Sander at the end of
the term?

We cannot solve this problem by solely using the basic simple interest concept. Compound Interest is the
type of interest that could possibly use to solve these types of problem.

There are two methods in computing the compound interest, the direct method and the use of compound
interest formula. We used the Direct Method earlier in the Paired Learning Activity. How was it? It’s
tiring right? That’s why this method is only applicable for a few numbers of interest periods.

It is evident that using the Direct Method is very time consuming. To lessen the laborious method of
solving compound interest, we can use the compound interest formula.

F = P(1 + r )t
Where:
P – principal or present value
F – maturity value at the end of the term
r – rate
t – term/time in years

Take note that this formula is used when we are solving for the maturity value.

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If you are solving for the Compound Interest ( I c ), it is given by:

Ic = F − P
Let’s now try to solve some practice problems.

Practice Problem #1:

Find the maturity value and the compound interest if P10, 000 is compounded annually at an interest
rate of 2% in 5 years.

Solution:
P = 10, 000 r = 0.02 t = 5 years
A. Let us solve for the Maturity Value first:
F = P(1 + r )t
F = 10, 000(1 + 0.02)5
F = 11, 040.81
B. Let us now solve for the Compound Interest:
Ic = F − P
I c = 11, 040.81 − 10, 000
I c = 1, 040.81

The future value F is P11,040.81 and the compound interest is P1,040.81.

Practice Problem #2:

Find the maturity value and interest if P50 000 is invested at 5% compounded annually for 8 years.

Solution:
P = 50,000 r = 0.05 t = 8 years
A. Solve for the Maturity Value

F = P(1 + r )t
F = 50, 000(1 + 0.05)8
F = 73,872.77
B. Solve for the Compound Interest
Ic = F − P
I c = 73,872.77 − 50, 000
I c = 23,872.77

The maturity value F is P73 872.77 and the compound interest is P23
872.77.

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Practice Problem #3:

Suppose your father deposited P10, 000 in your bank account at an annual interest rate of 0.5%
compounded yearly when you graduate from kindergarten and did not get the amount until you
finish Grade 12. How much will you have in your bank account?

Solution:
P = 10, 000 r = 0.005 t = 12 years

F = P(1 + r )t
F = 10, 000(1 + 0.005)12
F = 10, 616.78

The amount will become P10, 616.78 after 12 years.

What if we are asked to solve for other unknown values? Let us try solving the problem below

What is the present value of P50,000 due in 7 years if money is worth 10% compounded annually?

The problem is asking for the Present Value. To solve for this unknown value, we can use the formula for
compound interest.

F
F = P(1 + r ) t P=
(1 + r )
t

Where:
P – principal or present value
F – maturity value at the end of the term
r – rate
t – term/time in years

Let us now use the formula for present value and answer the problem.
Practice Problem #4:
What is the present value of P50,000 due in 7 years if money is worth 10% compounded annually?

Solution:
F = 50, 000 r = 0.1 t =7
F
P=
(1 + r )
t

50, 000
P=
(1 + 0.1)
7

P = 25, 657.91

The present value is P25, 657.91.

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Practice Problem #5:

How much money should a student place in a time deposit in a bank that pays 1.1% compounded
annually so that he will have P200,000 after 6 years?

Solution:
F = 200, 000 r = 0.011 t =6
F
P=
(1 + r )
t

200, 000
P=
(1 + 0.011)
6

P = 187, 293.65

The student should deposit P187,293.65 in the bank.

Lesson 2.3 – Compounded More Than Once a Year

Compounding More than Once a Year

mt
 i  ( m)
F = P 1 + 
 m 
Where:
P – principal or present value
F – maturity value at the end of the term
i(m)- nominal rate of interest (annual rate)
m – frequency of conversion
t – term/time in years

These are some of the important terms we must keep in mind to easily analyze and solve problems
involving compound interest:
1. Conversion of interest period – time between successive conversion of interests.
2. Frequency conversion (m) – number of conversion periods in one year
3. Nominal rate ( i ( m ) ) – annual rate of interest
4. Rate (j) of interest for each conversion period
i ( m) 𝑎𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒
j= = 𝑓𝑟𝑒𝑞𝑢𝑒𝑛𝑐𝑦 𝑜𝑓 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛
m
5. Total number of conversion periods (n): n = tm = (frequency of conversion) x (time in
years)

Finding Maturity Value, Compounding m Times a Year

Let us apply the formula mentioned above in solving problems.
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Practice Problem #6:

Find the maturity value and interest if P10,000 is deposited in a bank at 2% compounded quarterly
for 5 years?

Solution:
P = 10, 000 i (4) = 0.02 m=4 t = 5 years
mt
 i(m) 
F = P 1 + 
 m 
(4)(5)
 0.02 
F = 10, 000 1 + 
 4 
F = 11, 048.96

The future value F is P11,048.96

Ic = F − P
I c = 11, 048.96 − 10, 000
I c = 1, 048.96

The compound interest is P1,048.96.

Practice Problem #7:

Find the maturity value and interest if P10,000 is deposited in a bank at 2% compounded monthly for
5 years?

Solution:
P = 10, 000 i (12) = 0.02 m = 12 t = 5 years
mt
 i(m) 
F = P 1 + 
 m 
(12)(5)
 0.02 
F = 10, 000 1 + 
 12 
F = 11, 050.79

The future value F is P11,050.79

Ic = F − P
I c = 11, 050.79 − 10, 000
I c = 1, 050.79

The compound interest is P1,050.79.

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Practice Problem #8:

Patrick borrows P50,000 and promises to pay the principal and interest at 12% compounded
monthly. How much must he repay after 6 years?

Solution:
P = 50,000 i (12) = 0.12 m = 12 t = 6 years
mt
 i (m) 
F = P 1 + 
 m 
(12)(6)
 0.12 
F = 50, 000 1 + 
 12 
F = 102,354.97

Thus, Patrick must pay P102,354.97 after 6 years.

What if the problem is asking for the Present Value? Can we use the same formula?

We can manipulate the formula for Future Value to derive a formula for the unknown present value. If
you want to know a detailed process of the derivation, you can watch the video through this link:
https://www.youtube.com/watch?v=tiIRg-5_nww

mt
 i  ( m)
P=
F
F = P 1 +   i  (m) mt

 m  1 + 
 m 
Let us use the derived formula in solving problems.

Practice Problem #9:

Find the present value of P50,000 due in 4 years if money is invested at 12% compounded semi-
annually.

Solution:
F = 50, 000 i (2) = 0.12 m=2 t = 4 years

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F
P= mt
 i(m) 
1 + 
 m 
50, 000
P= (2)(4)
 0.12 
1 + 
 2 
P = 31,370.62

The present value is P31, 670.62.

Practice Problem #10:

What is the present value of P25,000 due in 2 years and 6 months if money is worth 10%
compounded quarterly?

Solution:
F = 25, 000 i (4) = 0.10 m=4 t = 2.5 years

F
P= mt
 i(m) 
1 + 
 m 
25, 000
P= (4)(2.5)
 0.10 
1 + 
 4 
P = 19,529.96

The present value is P19,529.96

Lesson 2.4 – Compounded Continuously

Interest can be compounded continuously like very hour, every minute or even a fraction of a second. If
the number of compounding m is to increase without bound, this procedure approaches what is called
continuous compounding.

If a principal P is invested at annual interest rate i ( m ) compounded continuously, then the amount F at the
end of t years is given by:

F = Pe i ( m )t

How can we apply this formula in solving problems involving compound interest compounding
continuously? Let us have examples.

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Practice Problem #11:

Suppose you invested P20,000 at 3% compounded continuously. How much will you have after 6
years?

Solution:
P = 20, 000 i ( m ) = 0.03 t =6

F = Pei
(m)
t

F = (20, 000)e(0.03)(6)
F = 23,944.35

Hence, the amount P20,000 will become P23,9444.35 if you invest it at 3%

compounded continuously for 6 years.

Study the problem below and identify what is being asked.

Practice Problem #12:

How long will it take P3,000 to accumulate to P3,500 in a bank savings account at 0.25%
compounded monthly?

If you think that it is asking for time. Then you’re right! Just like the Present Value, time is another
unknown value in a problem. And just like how we solved for the present value, we will also use the
formula for compound interest. For the detailed derivation and application of formula, you can watch
this video through this link: https://www.youtube.com/watch?v=OjgDVJEXMI0

To solve the problem, identify first the given:

P = 3, 000 F = 3,500 i (12) = 0.0025 m = 12

Now, we will use the compound interest formula compounding more than once a year and apply
the given to the formula.

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mt
 i (m) 
F = P 1 + 
 m 
12 t
 0.0025 
3,500 = 3, 000 1 + 
 12 
12 t
3,500  0.0025 
At this point, we = 1 + 
3, 000  12 
will be applying 12 t
 3,500   0.0025 
logarithm to log   = log 1 + 
 3, 000   12 
bring down the
 3,500   0.0025 
exponent. log   = 12t log 1 + 
 3, 000   12 
 3,500 
log 
 3, 000 
t=
 0.0025 
12t log 1 + 
 12 
t = 61.67

Thus, payments should be made for 740 months or 61.67 years.

Lesson 2.5 – Interest Rates in Compound Interest

Effective and Nominal Rate

1. Equivalent Rates – two annual rates with different conversion periods that will earn the same
compound amount at the end of a given number of years.
2. Nominal Rate – annual interest rate (may be compounded more than once a year.
3. Effective Rate – the rate compounded annually that will give the same compound amount as a
given nominal rate; denoted by i (1)

Illustration:

P800 is invested for one year. If the interest rate is

a. 9.04% compounded annually
b. 8.75% compounded quarterly
Determine the amount after one year.

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9.04% compounded annually is an effective rate

8.75% compounded quarterly is a nominal rate. EQUIVALENT

Let’s apply these concepts in an example.

Practice Problem #13:

At what interest rate compounded quarterly will money double itself in 10 years?

Solution:
F = 2P t = 10 m=4 j =?

2 P = P(1 + j )(4)(10)
2 = (1 + j ) 40
1
2 40
= (1 + j )
1
j = 2 −1
40

j = 0.0175
To compute for the nominal rate:

i (4) = mj
i (4) = (4)(0.0175)
i (4) = 7
The interest rate in each conversion period is 1.75% and the nominal rate is 7%.

Compound Interest Effective Rate Formula

The formula to calculate the effective rate of interest i (1) is given by:

Where:

i (1) = Effective rate of interest

m = frequency of conversions

i (m) = nominal interest rate (per year)

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Practice Problem #14:

What effective rate is equivalent to 10% compounded quarterly?

Solution:
i (4) = 0.10 m=4
m
 i(m) 
i (1)
= 1 +  −1
 m 
4
 0.10 
i (1)
= 1 +  −1
 4 
i (1) = 0.103813
Or 10.38%

Hence, the effective rate to 10% compounded quarterly is 10.38%

Key Concepts

✓ Compound interest means that the interest is calculated more than once during the time
period of the loan. When compound interest is applied to a loan, each succeeding time period
accumulates interest on the previous interest in addition to interest on the principal.
✓ Interest can be compounded annually, more than once a year (i.e. semi-annually, quarterly,
monthly, daily), or continuously.

Learning Activity

Tutorial Videos

For more information and examples, watch these videos:

1. Compound Interest Explained in One Minute: https://www.youtube.com/watch?v=jTW777ENc3c
(A more summed-up info and details about the basic concept of compound interest with the
use of practical examples and scenarios)
2. Simple vs. Compound Interest: https://www.youtube.com/watch?v=gyiiqUQgEeA
(In this video, simple and compound interest were thoroughly explained.)
3. Compound Interest Formula Explained, Investment, Monthly, & Continuously, Word
Problems, Algebra: https://www.youtube.com/watch?v=P182Abv3fOk
(This video will tackle the concept of compound interest in Finance and Business. This also
discusses the formula, variables, how to use it and example problems.)

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4. Derivation of Compound Interest Formulas:

https://www.webbertext.com/PDFiles/DerivForm4Ed.pdf
(This module gives the different formulas in solving unknown values involving compound
interest)
5. Deriving formulas for the present value of a series of regular payments:
https://www.youtube.com/watch?v=tiIRg-5_nww
6. Compound Interest - More than Once Per Year: https://www.youtube.com/watch?v=3vN-
6DA79N0
7. Effective Interest Rate vs Nominal Interest Rate | (EAR vs APR) | Explained with Examples:
https://www.youtube.com/watch?v=pwq_ajVXXnM

References

PatrickJMT. (2009, Mar 22). Compound Interest - More than Once Per Year. Youtube.

https://www.youtube.com/watch?v=3vN-6DA79N0

Tara Jones. (2016, Mar 25). Compound Interest: Solving for time. Youtube.

https://www.youtube.com/watch?v=OjgDVJEXMI0

Counttuts. (2019, Nov 11). Effective Interest Rate vs Nominal Interest Rate | (EAR vs APR) | Explained
with Examples. Youtube.

https://www.youtube.com/watch?v=pwq_ajVXXnM

One Minute Economics. (2016, Nov 26). Compound Interest Explained in One Minute. Youtube.

https://www.youtube.com/watch?v=jTW777ENc3c

The Organic Chemistry Tutor. (2016, Dec 7). Compound Interest Formula Explained, Investment,
Monthly & Continuously, Word Problems, Algebra. Youtube.

https://www.youtube.com/watch?v=P182Abv3fOk

Number Sense 101. (2019, Sep 12). Finding Maturity Value and Compound Interest (Compounded
Annually). Youtube.

https://www.youtube.com/watch?v=cOZNQKCP5sI

Number Sense 101. (2019, Sep 22). Finding Time in Compound Interest. Youtube.

https://www.youtube.com/watch?v=kV7yyswVgx8

Big Math Ideas. (n.d.). Formula for Compound Interest.

https://www.bigideasmath.com/protected/content/ipe_cc/grade%208/10/g8_10_02.pdf

Big Math Ideas. (n.d.). Simple and Compound Interest.

https://www.bigideasmath.com/protected/content/ipe/grade%208/10/g8_10_01.pdf

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Enrichment Activity

A. Complete the table by finding the unknown.

Compound
Rate Time
Principal (P) Interest Maturity Value (F)
(r) (t)
(Ic)
10 000 8% 15 (1) (2)
3 000 5% 6 (3) (4)
50 000 10.5% 10 (5) (6)
(7) 2% 5 (8) 157 500
(9) 9.25% 2.5 (10) 100 000

B. Solve the following problems:

1. On the 7th birthday of her daughter, Anna deposited an amount in a bank peso bond that pays
1% interest compounded annually. How much should she deposit if she wants to have
P100,000 on her daughter’s 18th birthday?
2. In a certain bank, Francis invested P88,000 in a time deposit that pays 0.5% compound interest
in a year. How much will be his money after 6 years? How much interest will he gain?
3. How much money must be invested to obtain an amount of P30,000 in 4 years if money earns
at 8% compounded annually?
4. A businessman invested P100,000 in a fund that pays 10.5% compounded annually for 5 years.
How much was in the fund at the end of the term?
5. How much should Apollo set aside and invest in fund earning 2.5% compounded quarterly if she
needs P75,000 in 15 months?
6. Find the compound amount due in 8 years if P200,000 is invested at 12% compounded quarterly.
7. Adriel borrowed P15,000 payable with interest that is compounded semi-annually at 9%. How
much must he pay after 3 years?
8. Julie is planning to invest P100,000. Bank A is offering 5% compounded semi-annually while
Bank B is offering 4.5% compounded monthly. If he plans to invest this amount for 5 years, in
which bank should she invest?
9. What present value, compounded daily at 0.6% will amount to P59,780.91 in 3 years?
10. Martha invested P400,000 in a boutique 5 years ago. Her investment is worth P700,000 today.
What is the effective rate of her investment?

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