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Business Management Report

This document discusses compound interest and how it differs from simple interest. It defines key terms like principal, compound amount, and conversion/compounding period. It shows how to calculate interest rates for different compounding periods (annually, semi-annually, etc.). Formulas are provided for calculating compound interest over time using accumulation factor and law of exponents methods. Examples are worked through to demonstrate calculating compound interest, compound amounts, and comparing results to simple interest calculations. Present value and compound discount are also introduced.

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Fenith Morandarte Manulong
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79 views

Business Management Report

This document discusses compound interest and how it differs from simple interest. It defines key terms like principal, compound amount, and conversion/compounding period. It shows how to calculate interest rates for different compounding periods (annually, semi-annually, etc.). Formulas are provided for calculating compound interest over time using accumulation factor and law of exponents methods. Examples are worked through to demonstrate calculating compound interest, compound amounts, and comparing results to simple interest calculations. Present value and compound discount are also introduced.

Uploaded by

Fenith Morandarte Manulong
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 15

CHAPTER TWO

“COMPOUND
INTEREST”
Compound Interest
-is the interest resulting from the periodic addition of simple interest to the
principal

Final/Compound Amount
- the resulting value when interest is periodically added to the principal

Compounding/Conversion Period
- the time between successive interest computations
When the conversion periods are:
annually m=1
semi-annually m=2
quarterly m=4
monthly m=12

The total number of conversion periods for the whole term can be found from the
relation:

n= time x number of conversion periods per year m


n= t x m
Thus, the term 5 years compounded:
annually 5x1 n=5
semi-annually 5x2 n=10
quarterly 5x4 n=20
monthly 5x12 n=60
Interest rate r
i =
conversion period per year m

i = r/m
Thus, the interest rate at 5% compounded:
annually 5%/1 i= 5%
semi-annually 5%/2 i= 2 ½%
quarterly 5%/4 i= 1 ¼%
monthly 5%/12 i= 5 ½%

Note: When no conversion period is stated in any investment problem, it is assumed that the investment is
compounded or converted annually.
Comparison of Simple Interest & Compound Interest
Compute the amount F or maturity value of a note at the end of 3 years, if the principal P or face value is
P800 and the interest rate r is 6% compounded semi-annually and compare the compound interest with
the simple interest for the same conditions as stated.

SIMPLE INTEREST COMPOUND INTEREST


Original Principal P800 Given:
Interest for the 1st year 48 (800 x .06) P= P800; t= 3yrs; r= 6%; m=2
Interest for the 2nd year 48 (800 x .06) Solution:
Interest for the 3rd year 48 (800 x .06) n= tm i= r/m
Amount at the end of 3 years 944 = 3(2) = 6%/2
Less the original principal 800 =6 = 3%
Total interest for 3 yrs P144
Original Principal P800.00
Interest for the 1st year 6 mos. (800 x .03) 24.00
Principal at the end of the 1st 6 mos. 824.00
Interest for the 2nd 6 mos. (824 x .03) 24.72
Principal at the end of the 2nd 6 mos. 848.72
Interest for the 3rd 6 mos. (848.72 x .03) 25.46
Principal at the end of the 3rd 6 mos. 874.18
Interest for the 4th 6 mos. (874.18 x .03) 26.23
Principal at the end of the 4th 6 mos. 900.41
Interest for the 5th 6 mos. (900.41 x .03) 27.01
Principal at the end of the 5th 6 mos. 927.42
Interest for the last 6 mos. (927.42 x .03) 27.82
Amount at the end of 3 years 955.24
Less original price 800.00
Total compound interest for 3 years P155.24
The fundamental formula for compound amount is:
F= P (1+i)n
1= F-P
where:
F= final or compound amount
P= original principal
i= periodic rate (i=r/m)
n= total number of conversion periods for the whole term (n=tm)
I= compound interest

The compound amount may be computed by the following methods:


I. Accumulation Factor Method
II. Law of Exponent Method
III. Approximate Accumulation Method
2.1 ACCUMULATION FACTOR METHOD
Examples:
1.Find the compound amount and interest if P5,500 is invested at 8% compod quarterly for
5 years and 6 months.
Given: P= P5,500 r= 8%, m=4 t= 5 yrs & 6 months
Solution:
i= r/m n= tm
= 8%/4 = 5 6/12(4)
= 2% = 22

F = P (1+i)n I = F-P
= P5,500 (1+2%)22 = P8,502.89 - 5,500
= P5,500 (1.545980) = P3,002.89
= P8,502.89
2. Accumulate P8,400 for 2 years at 7% converted monthly.
Given: P= P8,400 r= 7%, m=12 t= 2 years
Solution:
i= r/m n= tm
= 7%/12 = 2(12)
= 7/12% = 24
= .005833

F = P (1+i)n
= P8,400 (1+ 7 ½%)24
= P8,400 (1.149806)
= P9,658.37
3. What sum of money will be required to settle a loan of P8,700 on April 1, 2011, if the
loan is made on October 1,2002 at a rate of 9% compounded quarterly?

Given: P= P8,700 r= 9%, m= 4 t= Oct. 1,2002 to April 1,2011


Solution:
i= 9%/4 (2010)(16)
= 2 ¼% t= 2011-04-1
= .0225 2002-10-1
8-6 = 8 yrs & 6 mos.
n= 8 6/12 (4)
= 34

F = P(1+i)n
= P8,700(1+2 ¼%)34
= P8,700(2.130849)
= P18,538.39
4. Accumulate P15,400 for 5 years and 8 months at 5 1/2% compounded semi-annually.
Given: P= P15,400 r= 5 ½%, m=2 t= 5 yrs & 8 mos.
Solution:
i= r/m n= tm
= 5 ½% ÷ 2 = 5 8/12 (2)
= 2 ¾% = 11 ⅓
= .0275
Formula:
F = P(1+i)N (1+i)1/p
Table 2 Table 4

F= P15,400 (1+ 2 ¾%)11 (1+ 2 ¾%) ⅓


= P15,400 (1.347721) (1.009084)
= P20,943.44
LAW OF EXPONENTS
Illustrative Examples:
1. Find the compound amount and interest on P1,500 at the end of 35 years and 9 months,
if the interest rate is 6% compounded quarterly.
Given:
P= P1,500 r= 6% , m= 4 t= 35 years & 9 months
Solution:
i= r/m n= tm
= 6%/4 = 35 9/12 (4)
= 1 ½% = 143*
= .015
*143 is beyond the limit.
Formula:
F= P(1+i)n
= P1,500(1+1½%)100 (1+1½%)43
= P1,500(4.432046) (1.896880) Table 2
= P12,610.59

I= F-P
= P12,610.59- 1,500
= P11,110.59

2. Accumulate P1,100 at 8% compounded monthly for 25 years and 5 months.


Given: P= P1,100 r=8%; m=12 t=25yrs & 5 mos
Solution:
i= r/m n=tm
=8%/12 =25 5/12(12)
=2/3% =305*
=.006667
*305 is beyond the table limit
2.3 APPROXIMATE ACCUMULATION METHOD
Examples:
1. Accumulate P14,400 at 10½% compounded semi-annually for two years and ten months.
Given: P= P14,400 r=10½%; m=2 t= 2 yrs. & 10 mos.
Solution:
i= 10½%÷2 n= 2 10/12 × 2
=5¼ = 5 ⅔*
= .0525

2.4 PRESENT VALUE and COMPOUND DISCOUNT


Present value- the principal P which, if invested for the given time t at a given interest r, will amount to F on
the date F is due.

Compound discount D- is the difference between the final amount F and the present value P.
The present value at compound interest is given by:
P= F(1+i)-n D= F-P

The values of (1+i)-n are found in table 3 while the alternative formula
F
P= (1+i)n
may be used

The present value can be compounded by the following metthods:


I. Discounting Factor Method
II. Law of Exponents Methods
III. Approximate Discounting Method

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